What is CAGR in mutual funds? Advantages of CAGR. All you need to know
In the previous article, we discussed NFO in mutual funds. In this article, we will discuss CAGR in mutual funds
CAGR or Compound Annual Growth Rate refers to the mean annual growth of any investment over a period usually longer than a year.
It is an accurate way to calculate and determine the return for investment portfolios, and individual assets that may rise or fall in value with time.
Investment consultants who boast about their market knowledge and funds advertising their returns use the phrase CAGR.
- What exactly is meant by the term CAGR?
- How does the compound annual growth rate work?
- CAGR calculator and mutual funds
- Uses of a CAGR in Mutual fund
- How should investors interpret the compound annual growth rate over a period of time?
- The advantages of compound annual growth rate
What exactly is meant by the term CAGR?
The compound annual growth rate, or CAGR, measures your investments’ yearly compounding rate. Let’s spend some time considering the word compounding.
Imagine you put Rs 1,000 into stock and received a 10% return. In the first year, the stock price will have increased by Rs. 100. Now that we are in the second year, the price has risen by 10% once again.
Will the cost increase by Rs 1,200 after two years? The answer is no. After a year, your initial investment of Rs. 1,000 has increased to Rs. 1,100.
At this point, a 10% growth of Rs. 1,100 increases the investment’s worth to Rs. 1,210 after two years. The fundamental idea behind CAGR, or compound annual growth rate, is compounding.
How does the compound annual growth rate work?
Several restrictions are associated with calculating the mean or arithmetic average of results. Because it offers a rate of return that is smoothed, CAGR aids in overcoming them.
It may be used to compare the success of various assets over time and provides a reasonable prediction of the yields from an investment when compounded yearly.
Most of the time, when we evaluate the success of our assets, we are just interested in the total return. However, we frequently fail to consider the temporal worth of money. CAGR differs in this manner.
In actuality, CAGR prefers taking the time value of money.
CAGR calculator and mutual funds
Mutual fund investors can benefit significantly from the CAGR calculator. This can help you find out how good-performing your fund is for helping you take the required investment decisions.
Uses of a CAGR in Mutual fund
Compare returns between different funds and benchmarks
The CAGR calculator may also be used to contrast the returns you receive from one fund with those of other funds of a similar type. This might help you understand the mutual fund’s performance compared to its competitors. For further clarity, you may also evaluate against the benchmark indexes.
How should investors interpret the compound annual growth rate over a period of time?
As we previously mentioned, CAGR displays the average annual rate of return on your assets. CAGR accurately gauges an investment’s growth (or decline) over time.
A typical rule of thumb is that stocks generally favor firms with CAGR growth over 4-5-year intervals.
Profits are expected to be reinvested after each year of the time horizon for calculating CAGR. The CAGR is illustrative and inaccurate.
This is so that people understand that when you state something like “CAGR has risen 15% over five years,” it does not always indicate that it did so continuously over the five years.
It may have fluctuated between positive, flat, and even negative growth during this time.
Read more: What is XIRR in Mutual funds?
The advantages of compound annual growth rate
- It enables investors to evaluate the returns in various situations. For instance, you may model different CAGR scenarios to see how much your original investment would increase over time. It helps with financial planning.
- It is simple to use and comprehend. Only the beginning value, the end transaction, and the preferred investment time must be entered. You may simplify the calculation using internet calculators, excel spreadsheets, or scientific calculators.
- Absolute returns over a longer time horizon may be deceptive. In these situations, the CAGR can assist you in comparing with other comparable instruments to see whether you outperform the market. For instance, if you previously bought units of an equity fund and their value has since grown, you can efficiently utilize the CAGR to evaluate the average yearly gains you have achieved.
- When comparing CAGR to the cost of funds, it is essential to remember that CAGR is a return on the capital metric. For instance, to make a spread, you would need to look at an investment with a CAGR return of above 12% of your cost of funds was 9%.
CAGR is a beneficial formula for estimating an investment’s growth rate. It can help enhance the returns on the assets or evaluate historical profits as well.