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Author: gizmojwking Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75335  
Subject: Re: Is compound interest working? Date: 5/13/2010 10:49 PM
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In addition to the IRR calculation there is also something called CAGR (Compound Annual Growth Rate). This is a bit different that the IRR calculation in that you can view the one time investment if you have not put any additional money into the investment. The dividend reinvest will be part of your return. This is also called the geometric mean I believe but no matter. The formula is as follows.

CAGR = nth root of (ending value/initial value) -1

For your example you would use (18000-1200) as the intial value and 18000 as the ending value. The nth root is the time frame, in this case number of years so roughly 3 year or 1/3 root. You reference 4 years but I am assumuing 2007 to 2010 would rougly cover 3 years and not 4. Subracting the one gets you to the raw percentage. For your case you have a 2.33% CAGR for the 3 years you have held the stock. Probably not bad considering the brutal impact of the great recessions.

The formula in excel would be as follows.

=POWER((18000/(18000-1200)),(1/3))-1

If you just looked at the simple total % change the formula would be as follows (which you probably already know but just for grins here).

(now value - original value) / (original value)

(1200) / (18000-1200) = 7.14%

This is the total return but not the compounded return nor average yearly return. The IRR example given earlier in the chain uses multiple investments and I am not as familiar with this calculation. The CAGR equation above works when simply considering a starting intial value, and ending value, and a given time period. You can even use half or third years for the nth root, i.e. nth root = 1/3.5 = investment over 3.5 years.

I figured out an investment that may father had done with Dominion Resources (D) and handed off to me. He bought $2250 worth of shares 30 years ago and I determined the CAGR on that was roughly 11.5%. Not too shabby.

I also ran a 'what if' on JNJ as I have added that to my own IRA account recently and the stock with dividends invested did very well over a 14 year time frame which was the longest the tool I used would allow. So while the 2.33% may not seem like a great investment now I would guess you beat the S&P and other indexes as well taking into consideration the 'great recession'.

I hope this helps you out!

Gizmo (John)
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