What Is CAGR?
CAGR is the average annual growth rate of an investment over a given time period. The investment’s value is considered to be compounded over time. Unlike the absolute return, CAGR considers the time worth of money. As a consequence, it can accurately depict the annual returns on investment.
CAGR, or compound annual growth rate, demonstrates how the value of an investment rises over time. Simply said, it displays how much your investment has made each year over a certain time period.
CAGR Formula
The formula for compound annual growth rate (CAGR) is:
CAGR = [(Ending Value/Beginning Value) ^ (1/N)]-1
Here,
The value of the investment at the end of the investment term is referred to as the ending balance.
The value of the investment at the start of the investment term is referred to as the beginning balance.
N is the number of years invested.
Why Is CAGR Useful To You?
In general, consumers look at returns in absolute terms. Assume you have invested Rs. 1,200 in a mutual fund over a three-year period. Your investment was worth Rs.1,600 at the conclusion of the third year. Over the last three years, your fund has achieved an absolute return of 60%. During this time, your money has nearly doubled in value. This, however, can be deceiving. It does not inform you how much your investment has increased over time. This is when CAGR comes in handy.
Let’s compute the CAGR to better comprehend its benefits.
CAGR = [(1600/1200)^(1/3)] – 1
OR
CAGR = 10.05%
In other words, your investment in the fund has yielded an average annual return of 10.05% over the previous three years.
CAGR essentially informs you of the compounded annual returns you obtain regardless of the fund’s particular yearly performance.
This is due to the fact that your investments do not increase at the same rate year after year. You may have excellent returns in certain years while having low returns in others. It is possible to get negative returns as well.
CAGR informs you of the average returns achieved by a fund each year over a certain time period. This is not the actual rate of return. Rather, it is a graphical depiction of how much your investment would increase if it grew at the same pace every year.
CAGR Calculator
The CAGR calculator is a simple online tool that calculates the yearly rate of growth of your investment. All you have to do is enter some input data, and the calculator will handle the rest.
You must enter:
- The initial investment value
- The investment’s final value
- Number of years invested
- Once you provide this information, the calculator will calculate the investment’s compounded annual growth rate.
CAGR Calculator And Mutual Funds
CAGR Calculator And Mutual Funds You can use this calculator to understand how your fund is performing and take the appropriate investment measures. A CAGR calculator can assist you in the following ways:
Improved investment Decisions
The CAGR calculator is a very useful tool for analysing your investment selections each year. For example, if you bought an equity mutual fund five years ago, the CAGR calculator will show you the average annual rate of return for the last five years. This might help you determine whether the fund’s returns are in line with your expectations. If the fund is underperforming, you may want to evaluate your future investment.
Compare The Returns Of Various Funds And Benchmarks
You can also use the CAGR calculator to compare the returns of a certain investment to those of comparable funds. This might assist you in understanding how well the mutual fund performs in comparison to its contemporaries. For more clarity, you can also compare against the benchmark indices.
CAGR’s Limitations
- Market Volatility Is Not Reflected
CAGR measures the average growth of a stock or linked business factors in the absence of any external impact. It excludes the critical aspect of stock market volatility, which have a deep impact on the performance of listed firms. CAGR smooths out the variances in annual return rates of securities by taking an average of the same.
- Not Suitable For Risk Assessment
Because CAGR does not represent the volatility of a security trade in the stock market, individuals may not have a good picture of the instrument’s performance in the event of significant swings. The behaviour pattern of corresponding securities cannot be determined just by comparing a company’s CAGR, as this does not account for short-term changes. Other technical analysis methods should be used in conjunction to produce precise forecasts about the performance of a stock market instrument in order to invest in successful schemes.
- Not Suitable for SIP Investments
It is only appropriate for a one-time investment. Systematic investment at multiple time intervals is not included in the case of SIP investments, as only the initial amount is used to calculate CAGR.
Conclusion
CAGR is a highly useful measure for calculating an investment’s growth rate. It could be used to assess historical returns or forecast future returns on your assets. However, keep in mind that CAGR works best for lump sum investing. Systematic Investment Plans (SIPs) do not take recurring investments into consideration because the computation only examines the starting and end values. Overall, the CAGR calculator is a really handy tool for analysing your assets.
