CAGR: the honest measure of return
Compound annual growth rate answers a single question: what constant annual return would have taken you from your starting value to your ending value? It is the right number for comparing investments over different periods, and it is immune to the distortion that plagues simple averages.
Consider an investment that gains 50% then loses 50%. The simple average is 0%, but $100 became $75 — a CAGR of about −13.4%. Volatility drags on compounded outcomes, and only CAGR reflects that.
Fees are the most underrated variable
An expense ratio is charged on the whole balance every year, so its cost compounds alongside your returns. A 0.6% fee sounds trivial next to a 7% return, but it is roughly 9% of the return, every year, forever. Over 30 years that typically removes a fifth of the final balance. Unlike returns, this is a variable you can change today, permanently, by choosing cheaper funds.
Nominal versus real
A 9% nominal return in a 3% inflation environment is about 5.8% real. Real return is what determines whether your purchasing power actually grew. Long-run US equity returns of roughly 10% nominal correspond to about 7% real — and it is the 7% figure you should use for any planning that spans decades.
What this calculation cannot tell you
- Taxes. Realised gains, dividends and interest are taxed differently and by account type. After-tax return is lower again in a taxable account.
- Risk. Two investments with identical CAGR can have wildly different drawdowns. Return without volatility context is half the picture.
- Cash flow timing. If you added or withdrew money, use IRR rather than CAGR.
- Survivorship. Judging strategies by their winners systematically overstates what was achievable in advance.
A reasonable benchmark
Before congratulating yourself on a return, compare it to a low-cost total market index fund over the identical period, net of fees. Most active strategies underperform that benchmark over long horizons — the SPIVA scorecards published by S&P have found this consistently across decades and markets. Beating it is the bar; matching it cheaply is a perfectly good outcome.