Disadvantage: Investor ActionsĪnother disadvantage of the CAGR is that it does not account for the change in value caused by investor decisions to further fund or liquidate the asset. However, the CAGR assumes that the investment falls at a constant 3%, when, in fact, it grew by 25% in the first year.Ĭompound Annual Growth Rate can be used as a quick comparison tool between investment options, but any decisions should be made with consideration of the trade-offs between risk and return. This smoothing mechanism may yield results that differ from the actual situation with a highly volatile investment.īuilding on the above example, the CAGR correctly shows the ending value of the investment if a –3% CAGR was applied over a two-year compounding period. One disadvantage of the Compound Annual Growth Rate is that it assumes growth to be constant throughout the investment’s time horizon.
In contrast, the CAGR shows that the investment generated negative returns over its full time horizon. If all capital were reinvested in the same investment vehicle for the second year, which yielded a –25% return, the value of the investment would fall to $937.50, which is less than the initial investment amount.Īlthough it is clearly shown that the investment generated losses over a two-year horizon, averaging returns indicates that there was no change in returns over the two years. The example shows that the investment gave a 25% return in the first year, raising the value from $1,000 to $1,250. This advantage can be illustrated by the following example: One of CAGR’s advantages over an average annualized rate of return is that it is not influenced by percentage changes within the investment horizon that may yield misleading results. The Compound Annual Growth rate is a useful tool for comparing a variety of investments over a similar investment horizon.