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CAGRs vs Avg Rates

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  • CAGRs vs Avg Rates

    Hi All,

    I've been doing a fair amount of reading via blogs / books / articles I can get my hands on. Recently learned about CAGRs and how average rates are deceiving measures of return over the long term. Obviously those who are selling investment products will use the average rate as it is a higher number than CAGR more often than not, but is there a resource to find CAGRs? For instance, on all the popular Vanguard funds? Why even bother to use avg rates in the first place?

    Thanks

  • #2
    Average returns are nonsense for modeling calculations.  Use CAGR, or geometric mean.  The reason people advertise arithmetic means is because they're incentivized to - they're always going to be higher than the geometric mean.  If Fidelity starts advertising arithmetic mean returns while Vanguard advertises geometric means, which historically can be 1-2% lower, what do you think Vanguard is going to do?  This is like a game theory problem where all roads lead to advertisement of the average return.  It's the same for APR vs APY.  Credit cards and car dealerships will advertise a APR for debt because they look better than APYs (particularly for same day lenders which is a hilarious difference), and banks will advertise APYs for bank account interest.  It's all a game.  Just focus on two things always that cut through the BS - geometric mean and APY.  Here are historical market returns in both average and geometric mean returns:

    http://people.stern.nyu.edu/adamodar/pc/datasets/histretSP.xls

     

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    • #3
      All that matters for investments is CAGR, since that's how your money actually acts. If you gain 10% for 5 years, you haven't gained 5 * 10% = 50%, you've gained (1.1^5)-1 = 61%.

      All that matters for debts is the total paid in interest over the life of the loan. Trying to express that as CAGR as (total paid ÷ principal) ^ (1/years) will usually give you a CAGR "equivalent" of a loss of about half the nominal APR.

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