What CAGR tells you — and what it hides
CAGR — compound annual growth rate — converts a total gain into the steady annual rate that would have produced it. It answers one question well: at what constant rate did this investment grow between two dates?
Formula
CAGR = (Ending value ÷ Beginning value)^(1 ÷ years) − 1
- Beginning and ending values must be for the same investment
- Years can be fractional (18 months = 1.5)
- The result is expressed as an annual percentage
Why absolute returns mislead
An investment that grew from ₹2 lakh to ₹5 lakh delivered a 150% absolute return. Whether that is impressive depends entirely on how long it took: over seven years it is a CAGR of about 14%, over three years about 36%, and over twenty years just 4.7%.
This is why fund factsheets quote annualised rather than absolute returns for periods beyond a year, and why comparing an absolute gain from one investment with an annualised figure from another is meaningless.
What CAGR deliberately hides
CAGR is a smoothed figure. An investment that fell 40% and then tripled can show the same CAGR as one that rose steadily every year, and the experience of holding them is nothing alike.
It also says nothing about the path or the risk taken. Two funds with identical five-year CAGR can have very different volatility, drawdowns, and portfolio quality.
When to use XIRR instead
CAGR assumes one investment at the start and one value at the end. The moment you add or withdraw money in between — as every SIP investor does — it stops being the right measure.
For multiple cash flows on irregular dates, XIRR is the correct tool because it weights every contribution by how long it was invested. Use CAGR for a lumpsum, XIRR for anything with instalments.
Sanity-checking a CAGR claim
Two checks catch most exaggerated claims. First, confirm the period: a CAGR measured from a market bottom to a market peak flatters any equity investment. Second, check whether dividends or payouts were included or ignored.
For long-term equity comparisons, a decade or more covering at least one downturn gives a far more honest number than a three-year window.
Example: ₹2 lakh growing to ₹5 lakh
- Beginning value
- ₹2,00,000
- Ending value
- ₹5,00,000
- Absolute gain
- 150%
- CAGR over 3 years
- ≈ 35.7%
- CAGR over 7 years
- ≈ 14.0%
- CAGR over 20 years
- ≈ 4.7%
The same rupee gain looks like a spectacular investment, a good one, or a poor one depending only on the holding period. Always ask over what period a return was earned.