Which of the following is not correct about the Compound Annual Growth Rate (CAGR)?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → It is calculated by taking the arithmetic mean of series of returns.
The CAGR is the constant yearly rate that would take the beginning value to the ending value in n years:
\( \displaystyle \text{CAGR} = \left(\frac{\text{Ending value}}{\text{Beginning value}}\right)^{1/n} - 1 \)
It is a geometric (compound) average of the yearly growth, not the arithmetic mean of the yearly returns. For example, a return of +100% in one year and −50% in the next has an arithmetic mean of 25%, but the investment ends where it started, so the CAGR is 0%. Hence Option (4) is not correct.
Options (1), (2) and (3) are standard uses of CAGR: it puts the growth of different investments, advisors or business measures on the same yearly basis, so they can be compared.