Would we be doing something fair if we did not check the growth of our investments every year? Obviously no. But, the best part about this is that there are various sets of methods that you can use to calculate this growth. One of those many ways is – Compound Annual Growth Rate. What it is, how it works, and everything that revolves around this topic, we can speak here.
Most importantly, get ready to find out how you get to calculate your mutual fund growth through CAGR.
What is CAGR?
CAGR (Compound Annual Growth Rate) calculates the average annual growth rate of the investments over a certain time period. It displays the average rate of return on your assets over the course of a year. The compound annual growth rate is an essential tool for investors since it precisely gauges investment growth (or decline) over time. Profits are known to be reinvested at the end of each year of the time horizon when calculating CAGR.
As a result, CAGR is an indicative number rather than a precise return. Most investments do not grow at the same rate year after year. Regardless, the CAGR calculator is often used to compare different investments.
Keeping this typical application of the calculation in mind, investors should look for a simple technique to compute CAGR. The CAGR calculator can be used by anyone who wishes to measure their return on investment. The Compound Annual Growth Rate formula is employed in the computations of this application (CAGR formula). For example, if you have a mutual fund that has appreciated over time, you may use the calculator to calculate your rate of return.
How to Calculate CAGR?
Now that you have a fundamental understanding of the Compound Annual Growth Rate and its significance let’s dig deeper and learn how to calculate CAGR.
We’ll begin with the CAGR formula. The Compound Annual Growth Rate (CAGR) calculation for determining investment returns is as follows:
CAGR = (end balance/starting balance)
1/n – 1
Here,
- The value at the end of the investment period is referred to as the ending balance.
- The value of the investment at the start of the investment period is referred to as the beginning balance.
- N denotes the number of years invested.
Understanding the CAGR Formula in Depth
Let’s understand the CAGR formula:
Let me illustrate this with an example.
CAGR = (35000/20000)1/5 – 1
CAGR = 11.84%
This means that your mutual fund investment has delivered you an annual average return of 11.84%.
CAGR and Returns
Profits, sales, and investments all have one thing in common: you want to know how they increased over time. When the increase is over a year, it is quite straightforward. But what if your investment’s capital appreciation occurs over a longer period of 3-5 years? That is when CAGR comes into play.
CAGR is the most frequent of the several methods used to calculate returns over time. In other terms, CAGR is the annualized rate of growth of investment over time. It is a measure of how much your investments have increased over a specific period of time when compounding is applied on a yearly basis.
The beauty of CAGR is that it takes into account the monetary worth. For example, if Rs.100 grows to Rs.130 in three years, the yearly average return is 10%. However, there is a fault in that this does not account for the power of compounding and hence provides an inaccurate image of returns over a longer period of time.
How to Apply CAGR with Mutual Funds?
In reality, CAGR is one of the finest gauges of a mutual fund’s results over time. This is extremely straightforward for growth plans but can become tricky for dividend pay-out and dividend reinvestment plans. The notion of CAGR can be used to better accurately evaluate mutual fund returns and the investment performance over time. It considers the time value of money and assumes that all intermediate returns are properly reinvested in the portfolio.
As a result, it is more scientific.
Benefits of CAGR
- It enables investors to evaluate the returns in various circumstances. For example – you could simulate how much your original investment would increase over time under various CAGR scenarios. This is beneficial for financial planning.
- Absolute returns can be deceiving over long periods of time. In such circumstances, the CAGR can assist you in comparing your performance to that of other similar instruments to see if you are outperforming the market. For example, if you previously purchased units of an equity fund and their value has increased, you can easily use the CAGR to calculate your average annualized returns.
- It is simple to comprehend and apply. Only the initial value, end deal, and chosen investment time need to be entered. You can simplify the math by using online calculators, excel spreadsheets, or scientific calculators.
- You could also use the compound annual growth rate calculator to evaluate stock performance in the peer group and against the index to determine whether the stock or fund manager is outperforming the market benchmarks.
Conclusion
CAGR is considerably more trustworthy than other approaches for tracking the growth of an investment. This is mostly because the yearly return rate does not account for compounding, resulting in overestimation. Thus, understanding how a mutual fund grows in terms of CAGR is useful for comparing different funds. If such in-depth research does not appeal to you, you can invest in our hand-picked mutual funds from the country’s finest fund firms.
