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Recognising trends in growth is essential for success in the investment and financial markets. Among the most important metrics is the average annual growth rate (AAGR). But what is the annual growth rate?
AAGR is a simple term for a mean rate that shows how much an investment would have grown each year over time. It gives a steady growth rate that can help investors see how an investment or portfolio will do over time, which can help them make smart financial decisions.
This article’s goal is to define AAGR, provide a formula for it, and discuss its applications. It also aims to discuss the limitations of AAGR, providing a balanced view of this financial metric.
What is the average annual growth rate (AAGR)?
The average annual growth rate (AAGR) measures how much an investment has grown or earned on average over a certain period. Cryptocurrencies, stocks, bonds, futures, options, retirement plans, savings accounts, insurance policies, and more can all be screened using this procedure.
Remember that the AAGR is a way to measure growth that takes into account how smoothly it changes over time. The process of compounding, which can have a big impact on how much an investment grows over time, is not taken into account. AAGR also doesn’t consider the risks that come with an investment, like market volatility.
Because of this, AAGR can quickly show how well an investment is doing, but it should be combined with other financial measures to get the whole picture.
Calculation of AAGR
The AAGR can help you figure out long-term trends. It is helpful for different types of financial analysis, like displaying the trajectory of the business to investors by presenting the growth rate of metrics such as revenue, cash flow, expenditures, etc. The AAGR shows what the annual returns have been on average.
Average annual growth rate formula
AAGR = Growth 1+Growth 2+Growth 3+…+Growth nN
The growth 1, 2, 3 and so on depicts the growth rates of years 1, 2, 3 and so on.
N is the number of payments or periods
Example:
Assume that an investor, Ram has made an investment in a stock. The value of his stock at different time periods is as follows:
| Years | Investment |
| Year 1 | ₹500 |
| Year 2 | ₹550 |
| Year 3 | ₹550 |
| Year 4 | ₹600 |
| Year 5 | ₹600 |
Now, we have to calculate the year-on-year simple growth rates using the simple growth rate formula:
Simple growth rate = Closing ValueOpening value – 1
| Years | Investment | Growth |
| Year 1 | ₹500 | 0% |
| Year 2 | ₹550 | 10% |
| Year 3 | ₹550 | 0% |
| Year 4 | ₹600 | 9.09% |
| Year 5 | ₹600 | 0% |
Now, the average annual growth rate is:
AAGR = 0%+10%+0%+9.09%+0%5 = 3.818%
Therefore, the AAGR of the investment portfolio is 3.818%.
AAGR vs. CAGR
| AAGR | CAGR | |
| Meaning | It shows how much money an investment has made on average over a certain amount of time. | The steady rate at which an investment would have grown from its starting balance to its ending balance over a certain period. |
| Calculation | The arithmetic mean of annual growth rates is where AAGR can be determined. | To calculate CAGR, one uses this formula: CAGR=(Ending ValueBeginning Value)(1n)-1 |
| Compounding | AAGR can’t account for the effects of compounding. | CAGR takes compounding into account. |
| Practicality | AAGR is a simpler way to look at growth that gives you a quick picture. If there are big changes in the annual growth rates, though, it might not show the real growth pattern very well. | It is easier to use CAGR in real-life situations where compounding is important because it gives a smooth and realistic growth rate. |
Limitations of AAGR
The AAGR has many limitations, including the following:
Does not account for compounding: AAGR stands for the simple arithmetic mean of the yearly growth rates. It ignores compounding, which can have a vital influence on the long-term growth of an investment.
Ignores volatility: By reducing the impact of deviations, AAGR makes it easier to see patterns in growth rates. It doesn’t account for the fact that growth rates fluctuate throughout the time.
May misrepresent actual growth: If yearly growth rates vary greatly, AAGR—being average—may not be a good indicator of the true pattern of growth.
Not suitable for comparing investments: Since AAGR does not consider the passage of time, it might not be the best metric to come to light when comparing investments with diverse cash flows or time horizons.
Ignores risk: Investment risks are not taken into account by AAGR. As a result, you might not get the whole picture of an investment’s performance if you just use AAGR.
Bottomline
The average annual growth rate (AAGR) is a useful piece of financial information that tells you how much an investment has grown yearly on average. But it’s important to know that it has some flaws, like not taking volatility or compounding into account.
As a result, AAGR can be useful for financial analysis, but it should be combined with other measurements to get a full picture of how well an investment is doing.
FAQs
The growth rate summary is a brief report that shows how much a certain value, like a company’s revenue, has increased or decreased over a specific period. It’s usually expressed as a percentage. This summary helps to understand trends and make predictions about future performance.
The Compound Annual Growth Rate (CAGR) tells you the mean annual growth rate of an investment over a specified period longer than one year. It represents the consistent rate at which the investment would have grown if it had compounded at the same annual rate. CAGR is a more realistic measure of return than the Average Annual Growth Rate (AAGR) as it accounts for the effect of compounding which is a crucial aspect of investments.
Yes, the Compound Annual Growth Rate (CAGR) is considered a good indicator of an investment’s performance. It provides a smoothed annual yield, giving the illusion of steady growth, even when the underlying investment can vary significantly. CAGR helps fix the limitations of the arithmetic average return, making it a valuable tool for evaluating how different investments have performed over time. However, it’s important to remember that while CAGR is a useful measure, it does not reflect investment risk.
The Absolute Growth Rate (AGR) measures the total change in a particular quantity over a given period. In other words, it’s the actual increase or decrease in a value, not adjusted for the size of the initial value. For instance, if a company’s revenue grows from ₹1 million to ₹1.5 million in a year, the absolute growth rate is ₹0.5 million. However, AGR does not account for the effects of compounding or the relative size of the growth.
The Gross Domestic Product (GDP) growth rate is a measure of economic performance. It’s calculated by comparing the GDP of one period with the GDP of a previous period. Expressed as a percentage, it indicates the country’s overall economic health. A positive GDP growth rate signifies an expanding economy, while a negative rate indicates a contracting economy or recession. It’s a critical indicator used by policymakers, investors, and businesses for strategic decision-making.
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