What is 'Average Annual Growth Rate (AAGR)'

Average annual growth rate (AAGR) is the average increase in the value of an individual investment, portfolio, asset, or cash stream over the period of a year. It is calculated by taking the arithmetic mean of a series of growth rates. The average annual growth rate can be calculated for any investment, but it will not include any measure of the investment's overall risk, as measured by its price volatility.

BREAKING DOWN 'Average Annual Growth Rate (AAGR)'

The average annual growth rate is used in many fields of study.  For example, in economics, it is used to provide a better picture of the changes in economic activity (e.g. growth rate in real GDP).  

AAGR Example

The AAGR measures the average rate of return or growth over a series of equally spaced time periods. As an example, assume an investment has the following values over the course of four years:

  • Beginning value = $100,000
  • End of year 1 value = $120,000
  • End of year 2 value = $135,000
  • End of year 3 value = $160,000
  • End of year 4 value = $200,000

The formula to determine the percentage growth for each year is Percentage growth = (Ending value / Beginning value) -1

Thus, the growth rates for each of the years are as follows:

  • Year 1 growth = $120,000 / $100,000 - 1 = 20%
  • Year 2 growth = $135,000 / $120,000 - 1 = 12.5%
  • Year 3 growth = $160,000 / $135,000 - 1 = 18.5%
  • Year 4 growth = $200,000 / $160,000 - 1 = 25%

The AAGR is calculated as the sum of each year's growth rate divided by the number of years:

AAGR = (20% + 12.5% + 18.5% + 25%) / 4 = 19%

In the financial and accounting settings, typically the beginning and ending prices are used, but some analysts may prefer to use average prices when calculating the AAGR depending on what is being analyzed.

Average Annual Growth Rate vs. Compound Annual Growth Rate

AAGR is a linear measure that does not account for the effects of compounding. The above example shows that the investment grew an average of 19% per year. The average annual growth rate is useful for showing trends; however, it can be misleading to analysts because it does not accurately depict changing financials. In some instances, it can overestimate the growth of an investment.  For example, consider an end-of-year value for year 5 of $100,000.  The percentage growth rate for year 5 is -50%.  The resulting AAGR would be 5.2%; however, it is evident from the beginning value of year 1 and the ending value of year 5, the performance yields a 0% return.  Depending on the situation, it may be more useful to calculate the compound annual growth rate (CAGR). The CAGR smooths out an investment's returns or diminishes the effect of volatility of periodic returns.  

The formula for the CAGR is:

CAGR = (Ending value / Beginning value) (1/number of years) - 1

Using the above example for years 1-4, the CAGR equals:

CAGR = ($200,000 / $100,000) (1/4) - 1 = 18.92%

If year 5 were factored into the CAGR equation, the result would be 0%, which sharply contrasts the result from the AAGR.

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