The returns you earn on your investment play a significant role in determining whether you should stay invested. This also applies to mutual fund investments. However, there are a few ways to get insights on returns from mutual fund investments. One of these is calculating the Compound Annual Growth Rate (CAGR).

What is CAGR?

In simple terms, CAGR is the calculation of the year-on-year growth. It factors in the period for investment, making it more accurate and precise than the absolute returns you see.

 

Calculating CAGR is important over absolute growth because it gives you the average growth of your investment. For example, you see an absolute return of 40% in 3 years. While that is good, it does not paint the whole picture when you consider inflation and other factors.

 

CAGR offers a simple alternative by giving you an average constant growth rate. This can help you compare your investment with other avenues and maximise your profits.

How to Calculate CAGR?

You can do it manually, or use a digital calculator to get the value. For the manual calculation, the CAGR formula you can use is: 

 

{[(Current Value/Initial Value)^(1/tenor)]-1}*100

 

For example, you invest ₹1 Lakh, and it grows to ₹3 Lakhs in 7 years. Now, using the formula, you will get: 

{[(300000/100000)^(1/3)]-1}*100

 

Solving this, you will get a CAGR of 16.99%. 


Alternatively, you can use a CAGR calculator. Like the SIP calculator, this is an automated tool you can use and get the results in just a few minutes. To use the calculator, you will need the same values when using the formula.

Pros and Cons of CAGR

Here is a look at the top benefits of CAGR and some drawbacks you should keep in mind:

Pros:

  • Enables you to assess the returns and performance of the scheme

  • Offers you a more comprehensive and accurate look into your gains

  • Allows you to compare avenues across asset classes and make an informed decision

  • Simplifies calculations and requires minimal information

Cons:

  • Not ideal for evaluating the risk of your investment

  • Does not factor in the market volatility 

  • Although comprehensive, it may not give the complete picture

When to Use CAGR?

The primary use of CAGR is to understand the year-on-year growth of your investment and not just rely on the absolute returns. Apart from this, you can use this tool for the following reasons:

  • Compare Investment Avenues

Deciding the best investment instruments boils down to the returns you can earn from them. With CAGR, you get a simple way of calculating your returns and understanding the potential for financial growth.

  • Evaluate the Performance 

Evaluating past performance is a way to understand how the fund may perform in the future. Most AMCs offer a 1, 3, 5-year CAGR as well as an annualised return from inception.

Looking at this allows you to make an informed decision and choose the best scheme.

Key Points to Remember about CAGR

Here are some of the key things about CAGR when investing in a mutual fund:

  • The CAGR does not compute sales growth in a certain duration

  • Growth may only be focussed on the first and last year

  • The investments providing the same rate of return may be more profitable for you

  • This can happen as growth may be faster in the ones in the first year; it could increase with time for others

  • CAGR is often used for investments with a horizon ranging between three to seven years

  • Using CAGR for a longer investment horizon of 10 years or more can obscure any patterns you may find

  • Remember that CAGR is not the same as the annual growth rate

Relationship Between CAGR and Mutual Funds

When choosing a mutual fund, it is important to track its performance to check whether it is worth parking your money. A mutual fund fact sheet provides the growth rate of the fund across a variety of time periods.

 

Thus, it becomes difficult for the investors to evaluate its growth across various periods. This is where CAGR comes in handy. It allows you to compare a fund based on its single yearly growth rate.

 

Like other investment options, compound interest also plays a key role when you calculate the CAGR for a mutual fund scheme.

 

With a better understanding of the term CAGR, remember that it is not the only thing you can rely on. You also need to consider the risk of the scheme you invest in to ensure that it is within all the parameters of your preferences.

 

You can also invest in mutual funds on Bajaj Markets. With tools for easy comparison, you can choose from 1,000+ direct funds and invest with zero commission. Start investing today without any hassles through an end-to-end digital process.

FAQs on CAGR

What is a good CAGR?

A good CAGR in mutual funds depends on the type of scheme you are investing in. Ideally, it should beat inflation in the long term. Moreover, high-risk schemes should generally have a higher CAGR as your risk is high.

What is the CAGR formula for Excel?

The formula for CAGR is [(Current Value/Initial Value)^(1/tenor)]-1. You can write the values in an Excel sheet and then map them as per the formula to get your CAGR in just a few minutes.

Why is the CAGR important in mutual funds?

CAGR is important for mutual funds because it gives you better insights into your returns, allowing you to assess past performance and make an informed decision. You can also use it to compare different investment avenues and choose the best.

0% Commission | Seamless Onboarding | 1100+ Direct Fund Options | ELSS Tax-saving Mutual Funds Invest Now
Home
active_tab
Loan Offer
active_tab
Download App
active_tab
Credit Score
active_tab