Investment Return: Annualized Returns and CAGR Explained
Comparing investments is hard because returns are reported differently. CAGR is the metric that standardizes the comparison. Here is how to use it. Comparing investments is harder than it looks because returns are reported in different ways. One fund reports a 3-year total return of 30 percent. Another reports an average annual return of 9 percent. A third reports a CAGR of 8.7 percent. These numbers describe similar performance but in ways that are not directly comparable. After years of analyzing investment returns, here is how I standardize the comparison. Total Return: The Raw Number Total return is the simplest measure. It is the percentage gain or loss from start to finish, including dividends and interest. If I invest 10,000 dollars and end up with 13,000 dollars after 3 years, the total return is 30 percent. This number is easy to understand but misleading for comparison because it does not account for time. A 30 percent return over 3 years is very different from 30 percent over 10 years. Total Return = (Final - Initial) / Initial * 100 (13,000 - 10,000) / 10,000 * 100 = 30% I use total return when the time period is the same for all investments being compared. For comparing a 3-year fund to a 5-year fund, total return is useless. I need a time-normalized measure. The other trap is that total return hides the path.