Limitations of CAGR
The Compound Annual Growth Rate (CAGR) is a common way to measure growth in the business world. It gives a smoothed annual rate of growth over a certain amount of time. CAGR is a good way to look at the returns on investments or the success of a business, but it does have some flaws. Here are some things to think about,
1. Assumption of Constant Growth: CAGR assumes that the rate of growth will stay the same over the whole time, which might not always be the case. Growth rates can change from year to year, so CAGR may not be the best way to look at things.
2. Sensitive to Outliers: CAGR can be affected by data points that are outliers or have very high or very low numbers. It is possible for CAGR to not accurately show the overall growth if the values change a lot over periodnecessitatestime.
3. Ignores Timing and Volatility: CAGR doesn’t look at when gains will come in or how volatile the investment is. It treats every year the same and doesn’t take market ups and downs into account.
4. Doesn’t Take Risk into Account: CAGR doesn’t take risk or the fact that returns can change into account. Different investments with the same CAGR may have different amounts of risk, and CAGR may not tell you everything you need to know about how an investment is doing.
5. Single-Point Metric: The compound annual growth rate (CAGR) is a single-point metric that shows growth over a certain time frame. It doesn’t say anything about the steps the investment took to grow that much. A high CAGR investment may have gone through a lot of ups and downs along the way.
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