Average Annual Growth Rate (AAGR): Definition and Calculation
When an investment, portfolio, asset, or cash flow is valued annually, the average annual growth rate, or AAGR, indicates the mean rise in value. Compounding is not taken into consideration.
The formula for the average annual Rate (AAGR)
AAGR = GRa + GBb +…+GRn Ovcr N
Knowing What the Average Annual Growth Rate (AAGR) Means
The average yearly growth rate aids in identifying long-term trends. To give investors an impression of the company’s orientation, it may be used for nearly any financial metrics, such as growth rates of profits, revenue, cash flow, costs, etc. The ratio shows your average yearly return.
Finding the arithmetic mean of a range of growth rates yields the average yearly growth rate. The AAGR calculation, which is available for any investment, does not consider price volatility when calculating an investment’s overall risk. Additionally, the AAGR does not take periodic compounding into account.
The annualized average return on investments (AAGR) is a metric used to measure average returns over many periods. This amount is included in the prospectus of mutual funds and may be seen on brokerage statements. It is a succession of periodic return growth rates that are averaged.
One thing to remember is that you shouldn’t combine periods of various durations; instead, the periods should all be of identical length, such as years, months, or weeks.
AAGR Illustrations
The average rate of growth or return across a sequence of equally spaced time intervals is measured by the AAGR. These are two instances.
Investing Money
Assume, for four years, that an investment has the following values:
The initial value is $100,000.
The first year’s end value is $120,000.
At year’s end, the worth is $135,000.
Year three’s end value is $160,000.
Year 4 end value: $200,000.
The following formula is used to get the annual growth percentage:
Return or simple percentage growth = ending value + starting value minus 1
Easy % increase or return = starting value – finishing value
As a result, the following are the growth rates for each year:
Growth in year one is $120,000 / $100,000 – 1 = 20%.
The growth in year two is $135,000 / $120,000 – 1 = 12.5%.
Growing by $160,000 / $135,000 – 1 in year three equals 18.5%.
Growing by $200,000 / $160,000 – 1 = 25% in year four
The total annual growth rate divided by the number of years yields the AAGR:
The beginning and ending prices are typically employed in accounting and financial contexts. Some analysts might utilize average pricing when computing the AAGR depending on what is being studied.
Growth in the Gross Domestic Product (GDP)
Another illustration would be the actual gross domestic product (GDP) growth rate for the United States for the previous five years. From 2018 to 2022, the actual GDP growth rates in the United States were 1.8%, 2.6%, 7.0%, 3.9%, and 0.7%, respectively. Based on this, the five-year average growth rate (AAGR) of the real GDP of the United States is 3.2%, or 0.7% + 1.8% + 3.9% + 7.0% + 2.6% /5.
Compound Annual Growth Rate (AAGR)
The linear AAGR measurement does not take the effects of compounding into account. The example of financial investments above shows that growth over four years averaged 19% annually. Although it can help illustrate trends, the average annual growth rate may mislead analysts due to its imprecise representation of shifting financials. It may exaggerate an investment’s growth in some cases.
For the AAGR example above, let’s look at an end-of-year value of $100,000 for year five. In year five, the growth rate as a percentage is -50%. The initial value of year one and the ending value of year five show that, despite the 5.2% AAGR, the performance delivers a 0% return. Determining the compound annual growth rate (CAGR) could be more beneficial, depending on the circumstances.
The compound annual growth rate (CAGR) evens out investment returns or lessens the impact of periodic return volatility.
Formula for CAGR
CAGR =Ending BalanceBeginning Balance1# Years−1
Using the above example for years 1 through 4, the CAGR equals: CAGR=$200,000$100,00014−1=18.92%
The AAGR and CAGR have been quite close to each other throughout the first four years. In stark contrast to the 5.2% result from the AAGR, the outcome of the CAGR calculation would be 0% if year 5 were to be put in (-50%).
Constraints on the AAGR
Since AAGR is only a straightforward average of periodic yearly returns, it does not consider the investment’s overall risk based on its price volatility. For example, if a portfolio increases by 25% and 15% the following year, the average annual growth rate would be 20%.
To do this, inevitable measurement mistakes may arise since the investment’s return rate variations between the start and end of the first year are not considered in the computations.
The fact that it is a simple average and is unaffected by return timing is a second problem. For example, a sharp 50% fall in year 5 in the preceding scenario barely affects average yearly growth overall. CAGR, however, could be more helpful in comprehending how time-chained rates of development matter since timing is crucial.
What Can You Learn from the Average Annual Growth Rate (AAGR)?
The average annual growth rate, or AAGR, shows the long-term patterns of financial metrics like investment returns and cash flows. AAGR does not account for compounding but provides the average annual return.
What are the average annual growth rate restrictions?
If returns are both positive and negative, AAGR may exaggerate the growth rate. It also doesn’t account for the timing of returns or any other risk indicator, such as price volatility.
What Distinctions Exist Between Average Annual Growth Rate and Compounded Annual Growth Rate (CAGR)?
The average rise is called the average annual growth rate, or AAGR. This linear measure does not take compounding into account. In the meantime, the compound annual growth rate, or CAGR, works to even out the returns on investments, reducing the impact of return volatility.
How is the average annual growth rate (AAGR) determined?
Finding the arithmetic mean of a range of growth rates yields the average annual growth rate or AAGR.
Conclusion
- The average annualized return of a portfolio, asset, investment, or cash flow over time is known as the average annual growth rate, or AAGR.
- The primary arithmetic mean of a sequence of returns is used to compute AAGR.
- Compound annual growth rate, or CAGR, would be used in place of AAGR, as it is a linear metric and does not take compounding into account.
