Why CAGR beats average return
Averaging yearly returns overstates performance. A portfolio that gains 50% then loses 50% has an average return of 0%, but it is actually down 25% — the CAGR is about −13.4% a year, which is the honest figure.
CAGR smooths the path into the single compound rate that would have produced the same end value. It says nothing about volatility along the way, which is why it should be read alongside the largest drawdown, not instead of it.
What CAGR hides
CAGR describes the endpoints and nothing in between. Two investments with identical CAGR can have completely different experiences — one rising steadily, the other doubling then halving repeatedly. The second is far riskier despite the identical headline figure.
This is why CAGR should always be read alongside a volatility measure and the maximum drawdown. A 15% CAGR that involved a 60% fall along the way is not comparable to a 15% CAGR that never fell more than 10%.
CAGR and the rule of 72
Dividing 72 by a CAGR gives a close approximation of how many years an investment takes to double. At 8% that is nine years; at 12%, six years. The approximation holds well for rates between about 4% and 20%.
Run in reverse it is equally useful: if something doubled in five years, its CAGR was roughly 72 ÷ 5, or about 14.4%. The exact figure is 14.87%, which is close enough for mental arithmetic.
Frequently asked questions
Can CAGR be negative? +
Yes, whenever the final value is below the initial one. It cannot be computed at all if either value is zero or negative.
Is CAGR the same as annualised return? +
For a single lump sum with no additions or withdrawals, yes. Once cash flows in and out, you need money-weighted return (IRR) instead.
Can I compare CAGR across different periods? +
Only with care. A 20% CAGR over two years and over twenty are very different achievements, and short periods are heavily influenced by starting and ending conditions.