For example, you have invested $10,000 into an investment product for the past 3 years. For the past 3 years, the year to year returns were 10%, -6% and 15% respectively. Thus your initial capital would have grown to a level of $11,891 as given by the workings below.
Initial capital : $10,000
1st year return : $10,000 * 10% = $1,000
Final capital for 1st year : $10,000 + $1,000 = +$11,000
2nd year return : $11,000 * -6% = -$660
Final capital for 2nd year : $11,000 - $660 = $10,340
3rd year return : $10,340 * 15% = +$1,551
Final capital for 3rd year : $10,340 + $1,551 = $11,891
So what is the average returns for the past 3 years ? The formula is given below,
Thus for the previous examples, if we subsitute in the numbers, the formula will look like,
If we crunch the numbers and multiply by 100 to get the answer in terms of percentage, the answer will be 5.94%. To double-check the answer, we can do it by the long method again.
Initial capital : $10,000
1st year return : $10,000 * 5.94% = $594
Final capital for 1st year : $10,000 + $594 = +$10,594
2nd year return : $10,594 * 5.94% = $630
Final capital for 2nd year : $10,594 + $630 = $11,224
3rd year return : $11,224 * 5.94% = +$667
Final capital for 3rd year : $11,224 + $667 = $11,891
This means that on average, the initial capital of $10,000 grew at an average of 5.94% to achieve a final capital of $11,891. CAGR is often seen in the returns of stocks and funds where the returns is often given as CAGR as it is the average returns of the stocks and funds over a period of time.
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appreciate the clear explanation
ReplyDeleteGreat understanding. Thanks
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