What CAGR Hides
CAGR calculates a smooth growth rate using only the start and end values. $100,000 growing to $200,000 over 10 years shows a 7.2% CAGR whether the path was steady growth or a roller coaster with a 50% crash and recovery. CAGR completely erases the volatility experienced along the way, presenting two fundamentally different investment experiences as identical.
Same CAGR, Different Reality
Fund A delivers steady 7% annually. Fund B alternates between +30% and -10%, producing a higher 8.2% CAGR. But Fund B's investors endure gut-wrenching swings, and anyone who adds or withdraws money during the journey may earn far more or less than the stated CAGR. CAGR represents the return of a buy-and-hold investor who never touches the portfolio, a scenario that rarely matches reality.
Metrics to Use Alongside CAGR
Always pair CAGR with maximum drawdown (largest peak-to-trough decline) and standard deviation (return variability). A fund with 8% CAGR and -15% max drawdown is far more suitable for most investors than one with 10% CAGR and -50% max drawdown. The Sharpe ratio combines return and risk into a single number, revealing whether higher CAGR comes from skill or simply from taking more risk.