What is CAGR?
The full form of CAGR is Compound Annual Growth Rate. It is the measure determining the annual growth of your mutual fund investments spanned over a stipulated span. Basically, it is a unit for determining and assessing your yearly investment earnings during a specific period. This is considered to be the most reliable method for assessing the growth and fall of investment returns during a specific period.
What is the CAGR formula?
The standard formula for calculating CAGR is as follows:
CAGR= (Ending balance/beginning balance)1/n – 1, where, the ending balance determines the investment value during the end of a specific investment period, and the beginning balance is the investment level at the initial level, while n determines the tenure of investment.
Calculating CAGR
You need to follow a few simple steps for calculating the compounded growth rate of your investments:
- First, divide the ending investment value by the initial investment value. You can consider the output as ‘X’
- Then find out the ‘nth root of ‘X’
- Then, from this output subtract 1. The result you receive is the CAGR in terms of the decimal. To determine CAGR in percentage, simply multiply it by 100. The importance of the compound interest calculator is immense in this calculation,
The necessity of CAGR calculation
The general tendency of investors is to view their investments in absolute terms, which might prove to be misleading under certain circumstances. Such absolute assessments never reveal the yearly growth rate of your investment. CAGR’s importance lies here.
Suppose you have invested INR 1000 in a mutual fund, which amounted to INR 1850 after the third year. Applying the formula, CAGR= [1850/1000)^(1/3)]-1, which is 23%. This reveals that your investment has provided an average annual return of 23%.
Irrespective of the individual annual performances of the concerned fund, CAGR reveals the coumpounded annual interest earnings.
Since your investments pass through various market cycles, the growth or fall rate never remains static. CAGR averages out the entire picture and reveals the average yearly earnings by a certain specific fund over a stipulated span. This is never to be confused with the true return rate. Rather CAGR is a representational figure of your yearly investment growth.
CAGR calculator
The CAGR calculator is a simple online financial tool providing the true picture of the average annual growth rate of your investments. You simply need to enter the facts and figures and the calculator will work automatically. These figures include the ending investment value, the initial investment value and the tenure. The combination of the CAGR calculator and compound interest calculator reveals the true picture.
Necessity of CAGR calculator in mutual fund investments
The CAGR calculator is an indispensable tool for all mutual fund investors. Using this tool, you can easily understand well the overall performance of your investment. It helps you:
- Making better investment decisions: This handy financial tool helps in the practical analysis of your investment decisions, offering the average yearly return rate
- Comparison: Using this calculator, you can make a comparative study of different funds and proceed with your future investment strategies accordingly.
Shortcomings of CAGR calculation
Although CAGR calculation is an overall impressive measure for calculating compounded returns, it still possesses certain limitations:
- It never offers the ideal market volatility picture as the returns get smoothed in this process, giving you an average outcome
- CAGR assessment possesses the tendency for assuming that CAGR will continue to persist subsequently. However, the practical picture might differ
- CAGR proves to be ineffective in case of periodic investments like SIPs
CAGR- same as annualised returns?
No, these are different. Annualised returns always refer to simple annual returns as generated by a particular mutual fund scheme during a specific period of investment.
CAGR- same as IRR?
No, these two are also different. The IRR is a comparatively far superior measure during periodic inflows and outflows. CAGR considers only a single investment amount, while IRR offers the flexibility and capacity for returns calculation through several amounts of investments made during different periods.
Conclusion
CAGR is a handy tool for growth rate calculation in the case of a specific investment. You can utilise it for past evaluation or future estimation of the return on the investments. However, you must remember that CAGR suitably works for lump sum investments, when combined with a compound interest calculator. It is not quite suitable in the context of any periodic investments like SIP. Nevertheless, CAGR is highly useful and necessary for better analysis of your investments, eventually resulting in better financial management.
