The average annual growth rate (AAGR) reveals the mean increase in the value of an individual investment, portfolio, asset, or cash flow on an annualized basis. Unlike some other metrics, it doesn’t take compounding into account.
Key Takeaways
- Average annual growth rate (AAGR) is the average annualized return of an investment, portfolio, asset, or cash flow over time.
- AAGR is calculated by taking the simple arithmetic mean of a series of returns.
- AAGR is a linear measure that does not account for the effects of compounding—to account for compounding, compound annual growth rate (CAGR) would be used instead.
Formula for Average Annual Growth Rate (AAGR)
[ AAGR = \frac{GR_A + GR_B + … + GR_N}{N} ]
where:
- GR_A = Growth rate in period A
- GR_B = Growth rate in period B
- GR_N = Growth rate in period N
- N = Number of periods
Understanding Average Annual Growth Rate (AAGR)
The average annual growth rate helps determine long-term trends and applies to a wide array of financial measures such as profits, revenue, cash flow, and expenses. This ratio can provide investors with insights into the company’s direction and average annual return without considering price volatility or compounding effects.
AAGR provides a standard measure for average returns over multiple periods and can be found in several financial documents like brokerage statements and mutual fund prospectuses. It’s calculated by averaging out a series of periodic return growth rates. Ensure that all periods are of equal length to maintain accuracy.
Examples of Applying AAGR
Financial Investment
Assume an investment has these values over four years:
- Beginning value: $100,000
- End of year 1: $120,000
- End of year 2: $135,000
- End of year 3: $160,000
- End of year 4: $200,000
To determine the percentage growth for each year: [ \text{Simple percentage growth} = \frac{\text{Ending value}}{\text{Beginning value}} - 1 ]
Growth rates per year:
- Year 1: [(120,000 / 100,000) - 1 = 20%]
- Year 2: [(135,000 / 120,000) - 1 = 12.5%]
- Year 3: [(160,000 / 135,000) - 1 = 18.5%]
- Year 4: [(200,000 / 160,000) - 1 = 25%]
So, the AAGR: [ AAGR = \frac{(20% + 12.5% + 18.5% + 25%)}{4} = 19% ]
Gross Domestic Product (GDP) Growth
Examining the U.S. real GDP growth rates from 2018 to 2022:
- 2018: 0.7%
- 2019: 1.8%
- 2020: 3.9%
- 2021: 7.0%
- 2022: 2.6%
Thus, the AAGR: [ AAGR = \frac{(0.7% + 1.8% + 3.9% + 7.0% + 2.6%)}{5} = 3.2% ] AAGR is helpful in servicing several needs but has limitations such as not accounting for periodic compounding or overall risk and price volatility.
AAGR vs. Compound Annual Growth Rate
AAGR does not account for compounding. The CAGR smooths out returns or diminishes periodic volatility effects:
Formula for CAGR
[ CAGR = \left(\frac{\text{Ending Balance}}{\text{Beginning Balance}}\right)^{\frac{1}{\text{# Years}}} - 1 ] Using the previous investment example from years 1 to 4: [ CAGR = \left(\frac{200,000}{100,000}\right)^{\frac{1}{4}} - 1 = 18.92% ] Including a negative growth rate can dramatically alter the AAGR versus the CAGR.
Limitations of the AAGR
- It does not account for risk or volatility between periods.
- It does not consider the timing of returns, which can skew insights provided.
Discovering AAGR’s Benefits and Drawbacks
The AAGR is invaluable for identifying long-term trends but has to be used with awareness of its limitations. For compounded effects and more detailed analysis, consider using other metrics such as CAGR.
FAQs
What does the Average Annual Growth Rate (AAGR) tell you?
AAGR identifies long-term trends of finance measures like cash flows or investment returns, explaining the average annual return without considering compounding.
What are the limitations of Average Annual Growth Rate?
AAGR may overestimate growth rates if there are both positive and negative returns and does not consider risk factors like price volatility nor the timing of returns.
How does Average Annual Growth Rate differ from Compounded Annual Growth Rate (CAGR)?
AAGR is a linear measure without compounding impacts, while CAGR smooths out returns and reflects volatility in periodic returns.
How do you calculate the Average Annual Growth Rate (AAGR)?
AAGR is calculated by finding the arithmetic mean of a series of growth rates.
Related Terms: Compound Annual Growth Rate (CAGR), Rate of Return, Arithmetic Mean, Financial Analysis, Investment Portfolio.
References
- Federal Reserve Bank of St. Louis. “Table 1.1.1. Percent Change From Preceding Period in Real Gross Domestic Product: Quarterly”.
