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What Is CAGR? Compound Annual Growth Rate Explained for Traders

· 2 min read
Vaanam
Vaanam
Build, Backtest, and Screen Trading Strategies

CAGR stands for Compound Annual Growth Rate. It tells you what your strategy's annualized return would be if it grew at a steady rate every year.

Why Not Just Use Total Return?​

Say a strategy returns 100% over 10 years. Sounds okay, right? But another returns 100% over 3 years. Clearly different — but "100% total return" doesn't tell you that.

CAGR normalizes returns to a per-year basis so you can compare strategies across different time periods.

The Formula​

CAGR = (Final Value / Initial Value) ^ (1 / Years) - 1

Example: You start with $100,000 and end with $434,835 after 20 years.

CAGR = (434,835 / 100,000) ^ (1/20) - 1
     = 4.3483 ^ 0.05 - 1
     = 0.0775
     = 7.75%

So even though the total return is 334%, the annualized growth rate is 7.75%.

What's a Good CAGR?​

It depends on context:

BenchmarkTypical CAGR
S&P 500 (long-term)~10%
Risk-free rate (T-bills)~4-5%
Hedge funds (average)~8-12%

But CAGR alone doesn't tell the full story. A 15% CAGR with 50% max drawdown is very different from 15% CAGR with 10% max drawdown. Always pair CAGR with risk metrics like max drawdown, Sharpe ratio, or Calmar ratio.

CAGR vs. Average Return​

These are not the same. Average return ignores compounding.

  • Year 1: +50%, Year 2: -50%
  • Average return: 0%
  • Actual result: $100 → $150 → $75 (you lost 25%)
  • CAGR: -13.4%

CAGR reflects what actually happened to your money. Average return can be misleading.

Key Takeaway​

CAGR is the single best number for comparing strategy returns across different time periods. But never look at it in isolation — pair it with drawdown and risk-adjusted metrics for the full picture.