How To Calculate CAGR in Excel

How to Calculate CAGR in Excel: A Step-by-Step Guide
Compound annual growth rate, or CAGR, is one of the most important metrics for evaluating the historical return of an investment over time. It allows you to boil down the total return into an annualized figure that can be used to compare against other investments.
In this guide, I‘ll explain exactly what CAGR tells you, why it matters, and most importantly, how to quickly and easily calculate it in Microsoft Excel with multiple methods. I‘ll provide detailed steps along with an example data set so you can follow along and master this essential skill. Here‘s what we‘ll cover:

  • What is CAGR and why does it matter?
  • The formula for calculating CAGR
  • How to calculate CAGR in Excel (step-by-step)
    • Using the CAGR formula
    • Using the RATE and RRI functions
  • Interpreting and using the CAGR result
  • Pros and cons of the CAGR metric
  • Additional resources and Excel templates

By the end of this article, you‘ll know how to calculate CAGR like a pro and understand both the benefits and limitations of this widely used investment performance metric. Let‘s dive in!

What is CAGR?
CAGR stands for compound annual growth rate. It represents the annualized rate of return for an investment over a multi-year time period.
Essentially, CAGR shows you the rate at which an investment would need to grow each year to reach its ending value, assuming the gains are reinvested at the end of each period. This gives you a "smoothed" annual return figure that can be used to compare investments of unequal time periods.
For example, let‘s say you are evaluating two mutual funds for a retirement account. Fund A grew 50% over the past 3 years, while Fund B grew 100% over the past 5 years. Which one had the better annual return?
It‘s not immediately clear because the time periods are different. That‘s where CAGR comes in. By calculating the CAGR, you could compare the two investments on an apples-to-apples basis and see which one actually performed better on an annualized basis.

Why CAGR Matters
There are a few important reasons why investors and finance professionals rely on CAGR:

  1. Smooths out volatility: By nature, investments can have very different return profiles from year to year. One year could be way up, the next could be way down. CAGR gives you an average annual return figure that smooths out those peaks and valleys.

  2. Allows comparison of different time horizons: It‘s very common to analyze investments that have differing lifespans. CAGR puts them on equal footing so you can objectively compare them. It tells you which investment grew the most on an annualized basis.

  3. Widely used and recognized: CAGR is a very standard metric in the world of investing and finance. If you‘re discussing historical returns with colleagues or clients, they will expect it to be presented in CAGR terms. It provides a common language.

So in summary, calculating CAGR is essential for evaluating and comparing investment performance in an objective way that controls for both time and volatility. Now let‘s look at how it‘s actually calculated.

The CAGR Formula Explained
Here is the formula for CAGR:

CAGR = (Ending Value / Beginning Value)^(1 / n) – 1

Where:

  • Ending Value is the investment‘s value at the end of the time period being measured
  • Beginning Value is the investment‘s starting value
  • n is the number of years between the beginning and ending values

To explain this in plain English, you divide the ending value by the beginning value, then raise that to the power of one divided by the number of years. Then you subtract one from that result to get the annualized return percentage.
This is the basic CAGR equation. You could calculate it by hand with a calculator, but it‘s much faster to set it up in Excel, especially if you need to evaluate many investments. Here‘s how to do it.

How to Calculate CAGR in Excel
Now I‘ll walk through how to set up the CAGR calculation in Excel step-by-step. We‘ll use the example data set below for a hypothetical 5-year investment:

Year 1: $10,000
Year 2: $12,000
Year 3: $13,000
Year 4: $15,000
Year 5: $18,000

In this case, the beginning value is $10,000, the ending value is $18,000, and the number of years (n) is 5. Here‘s how we would calculate the CAGR:

Method 1: Using the CAGR Formula

  1. Set up your data in columns with years (or time periods) in the first column and the investment values in the second column. You can label the columns if you want.

  2. In a blank cell, type "=(B6/B2)^(1/A6)-1" and hit Enter. The "=" tells Excel it‘s a formula. B6 is the ending value, B2 is the beginning value, and A6 is the number of years.

  3. Format the result as a percentage by selecting the cell, clicking the Home tab, and selecting Percentage from the Number group.

The formula result shows that the 5-year CAGR for this investment was 12.47%. You could check this with the manual calculation:
CAGR = (18000 / 10000) ^ (1/5) – 1 = 12.47%

Method 2: Using the RATE Function
For a slightly easier approach, you can use the RATE function to calculate CAGR. Here‘s how:

  1. With your data set up as in the previous example, go to a blank cell and type "=RATE(A6,,−B2,B6)" and hit Enter.
  • A6 is the number of years
  • B2 is the beginning value, which is entered as a negative number
  • B6 is the ending value
  1. Format the result as a percentage.

The RATE function handles the exponent and subtracting one, so it‘s a little faster than the full formula. The result is the same: 12.47% CAGR.

Method 3: Using the RRI Function
For the simplest method, use the RRI function, which is tailor-made for calculating annualized return rates like CAGR. Here‘s how:

  1. With your data set up, go to a blank cell and type "=RRI(A6,B2,B6)" and hit Enter.
  • A6 is the number of years
  • B2 is the beginning value
  • B6 is the ending value
  1. Format the result as a percentage.

Again, the result is 12.47% CAGR. The RRI function is the most straightforward way to calculate CAGR in Excel, as long as you know the syntax.

Evaluating the CAGR Result
Now that you know three ways to calculate CAGR in Excel, let‘s discuss how to interpret and use the result.
In general, a higher CAGR is better than a lower one. It means the investment grew at a faster annualized rate over the measured time period. In our example above, a 12.47% CAGR means that the investment grew by an average of 12.47% per year for 5 years, resulting in an 80% total return ($10,000 to $18,000).
CAGR is most useful as a comparison tool. You can calculate the CAGRs of various investments to see which had the best annual return. The investments could be stocks, bonds, real estate, or even entire portfolios.
For instance, consider the CAGR of the S&P 500 stock market index over the past 3, 5, and 10 years (as of February 2023):

  • 3-year CAGR: 7.66%
  • 5-year CAGR: 9.53%
  • 10-year CAGR: 12.39%

This tells us that $10,000 invested in an S&P 500 index fund 10 years ago would have grown to $32,319 by February 2023, assuming dividend reinvestment. That‘s an annualized return of 12.39%.
You could compare this to other stock market indices, bonds, real estate, or individual stocks over the same time period to see how the S&P 500 stacks up. Whichever has the highest CAGR was the best performing investment on an annualized basis.
Limitations of CAGR
While CAGR is a very useful metric, it‘s not perfect, and investors should understand its limitations:

  1. Sensitive to time period: CAGR can change drastically depending on the start and end dates used. For example, the 10-year CAGR of the S&P 500 through March 2009 was -3% due to the Financial Crisis crash, but through March 2010 it was 1.4% because of the steep recovery. It‘s important to be aware of the time period used when comparing CAGRs.

  2. Doesn‘t reflect interim volatility: CAGR gives a smoothed annual return, but investments rarely move in a straight line. There can be many ups and downs in between the start and end points that aren‘t reflected in the CAGR. It‘s wise to look at metrics like standard deviation as well to get a sense of an investment‘s volatility.

  3. Not the same as actual year-to-year returns: The CAGR almost never matches the actual return in any given year. It‘s a long-term average. Some years will be higher, some lower, and some may even be negative. Investors must understand this to have realistic expectations and properly assess risk.

So while CAGR is a very important metric, it works best in combination with other evaluation tools. I recommend using it as a starting point for investment comparisons and analysis, but always dig deeper to get a complete picture.

Additional Resources
To go even further with calculating and using CAGR in Excel, check out these handy resources:

  • HubSpot Spreadsheet Template Directory: Downloadable Excel templates for calculations like CAGR, ROI, IRR, budgeting, and more
  • Microsoft Guide to the RATE and RRI Functions: Detailed look at these handy financial functions with more examples
  • Investopedia‘s Guide to CAGR: In-depth look at the concept of CAGR and how it‘s used in investing

I hope this guide has given you the knowledge and tools you need to calculate CAGR in Excel quickly and confidently. By mastering this skill, you‘ll be able to objectively size up and compare any type of investment to make smarter financial decisions. Remember, the Excel functions make it easy, but always take the time to interpret the results wisely. Here‘s to many happy returns!

Tags: