One of the calculations that you’ll hear thrown around time and time again is the compound annual growth rate. It’s a more accurate measure of past investment performance than just a simple average of the different years investment returns. Knowing what the average return of some investment is doesn’t give you any insight into what you might actually expect to have as a result of some initial investment.

To illustrate this, consider the example of two consecutive years where you earn 50% the first year and then lose 33% the next. If you average these returns, you end up with a 8.5% return on your investment, which doesn’t sound that bad. But if you actually run the numbers on some initial investment, you can see that the actual two year return was 0%.

So here’s how you calculate the Compound Annual Growth Rate (CAGR):

CAGR = [Ending Balance/Beginning Balance]^(1/Time Period, i.e. number of years)

It’s a relatively simple calculation to make, and it’s important because you can then equally compare the returns from different investments. I will caution you though, that just because you know the CAGR of some investment in the past, it cannot accurately predict the future returns of the investment.

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