The most important distinction is that the CAGR is straightforward enough that it can be calculated by hand. In contrast, more complicated investments and projects, or those that have many different cash inflows and outflows, are best evaluated using IRR.
Which is better, XIRR vs CAGR? It depends on the type of investment. For investments with regular cash flows, such as lump sum investments, CAGR is a good enough measure of returns. However, for investments with irregular cash flows, such as SIPs, XIRR is a better measure of returns.
The IRR doesn't take the actual dollar value of the project or any anomalies in cash flows into account. If there are any irregular or uncommon forms of cash flow, the rule shouldn't be applied. If it is, it may result in flawed findings.
The Internal Rate of Return (IRR) is a widely used financial metric for evaluating investment projects, but it can have some limitations. One of the key pitfalls is when the project exhibits unconventional cash flows that is, when there are multiple sign changes in the cash flow stream.
So the rule of thumb is that, for “double your money” scenarios, you take 100%, divide by the # of years, and then estimate the IRR as about 75-80% of that value. For example, if you double your money in 3 years, 100% / 3 = 33%. 75% of 33% is about 25%, which is the approximate IRR in this case.
Disadvantage of CAGR: Smoothing and Risk
One disadvantage of the Compound Annual Growth Rate is that it assumes growth to be constant throughout the investment's time horizon. This smoothing mechanism may yield results that differ from the actual situation with a highly volatile investment.
Both CAGR and absolute returns are considered valuable metrics when it comes to evaluating investment performance, but the key difference lies in their approach to time. Generally, CAGR is a preferred metric for longer-term investments.
You may consider CAGR of around 5%-10% in sales revenue to be good for a company. CAGR is used to forecast the growth potential of a company. For a Company with a track record of over five years, you may consider a CAGR of 10%-20% to be good for sales.
What is the Rule of 72? Here's how it works: Divide 72 by your expected annual interest rate (as a percentage, not a decimal). The answer is roughly the number of years it will take for your money to double. For example, if your investment earns 4 percent a year, it would take about 72 / 4 = 18 years to double.
The Rule of 70 Formula: It means, the doubling time is simply 70 divided by the constant annual growth rate. For instance, consider a quantity that grows consistently at 5% annually. According to the Rule of 70, it will take 14 years (70/5) for the quantity to double.
The modified internal rate of return (MIRR) allows you to adjust the assumed rate of reinvested growth at different stages of a project or investment. It is more accurate than IRR because it avoids overstating the potential value of a project due to variations in cash flows.
CAGR is the best formula for evaluating how different investments have performed over time. Investment results can vary depending on the time periods that are used. Investors can use a risk-adjusted CAGR to compare the performance and risk characteristics between investment alternatives.
XIRR (Extended Internal Rate of Return) is a metric used to measure the performance of mutual funds and other investments that involve multiple cash flows. XIRR is especially useful for investments with irregular cash flows, like mutual funds, where contributions and withdrawals happen at different times.
ROI and IRR are complementary metrics where the main difference between the two is the time value of money. ROI gives you the total return of an investment but doesn't take into consideration the time value of money. IRR does take into consideration the time value of money and gives you the annual growth rate.
The IRR is also a rate of return (RoR) metric, but it is more flexible than CAGR. While CAGR simply uses the beginning and ending value, IRR considers multiple cash flows and periods—reflecting the fact that cash inflows and outflows often constantly occur when it comes to investments.
Usually, anything under an 8% CAGR is poor, but a good rate really does depend on the specific organisation. For example, companies who have been around for 10 or more years may see a CAGR of 8%-12% which is a good rate of sales for the amount of time they have been in business.
CAGR is better than a simple average because it accounts for the compounding effect, providing a more accurate measure of growth over time. A simple average might ignore the compounding returns and fluctuations in the investment's performance, potentially leading to misleading conclusions about growth rates.
Next, determine the ending value, which is the value at the end of the specified period. Now, calculate the total number of years over which the growth occurred. Use the CAGR Formula: CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) – 1.
CAGR is a simple metric that measures the average rate of growth of a sum, be that a figure like sales or an investment, over any number of periods. It's easy to picture visually: In Example 1 above, a $1.00 investment grows by 20% for three years to a value of $1.73. The CAGR is 20%.
A good CAGR for large companies in an industry ranges from 8% to 12%, whereas high-risk companies aim for a compound annual growth rate between 15% to 25%.
For example, the Rule of 72 states that $1 invested at an annual fixed interest rate of 10% would take 7.2 years ((72 ÷ 10) = 7.2) to grow to $2. In reality, a 10% investment will take 7.3 years to double (1.107.3 = 2).
There isn't a one-size-fits-all answer, but generally, an IRR of around 5% to 10% might be considered good for very low-risk investments, an IRR in the range of 10% to 15% is common for moderate-risk investments, and in investments with higher risk, such as early-stage startups, investors might look for an IRR higher ...
The IRR rule states that if the IRR on a project or investment is greater than the minimum RRR—typically the cost of capital, then the project or investment can be pursued. Conversely, if the IRR on a project or investment is lower than the cost of capital, then the best course of action may be to reject it.