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Understanding CAGR - Compound Annual Growth Rate

Understanding the performance of your investments over time is essential for effective financial planning. While absolute returns may  offer a limited view on performance of the portfolio, the Compound Annual Growth Rate (CAGR) represents the average annual growth rate of an investment over a specific period. It essentially smooths out the fluctuations in yearly returns to present a consistent growth trend.

Why CAGR is Important for Investors:

  • Provides a Long-Term Performance Overview: CAGR offers a measure of growth rate over multiple years, giving an indication of long-term performance rather than individual annual returns.
  • Facilitates Investment Comparison: CAGR provides a standardized way to compare the growth of different investments over the same time period such as mutual funds, stocks, and other assets.
  • Enables Benchmarking: Investors can use CAGR to compare the performance of their investments against relevant market indices.

The Formula for Calculating CAGR:

The calculation for CAGR involves a straightforward formula:

CAGR=((Ending Value/Beginning Value​)^1/n)−1

Here's a breakdown of the terms:

  • Ending Value: The value of the investment at the end of the specified period.
  • Beginning Value: The initial value of the investment at the start of that period.
  • Number of Years: The duration of the investment period in years.

*Understanding CAGR Through a Table:

Consider an investment of ₹5,000 over 4 years with the following year-end values:

Year

Beginning Value (₹)

Ending Value (₹)

Absolute Returns

1

5,000

5,750

15%

2

5,750

5,175

-10%

3

5,175

6,210

20%

4

6,210

6,831

10%

Calculating the CAGR:

  • Beginning Value: ₹5,000
  • Ending Value: ₹6,831
  • Number of Years: 4

CAGR= (6831/5000​)^¼)​−1

CAGR=((1.3662)^0.25)−1

CAGR≈1.0817−1

CAGR≈0.0817 or 8.17%

*The above example is for illustrative purposes only and does not represent actual returns of any specific investment. Past performance may or may not be sustained in the future. Returns are subject to market risks and other factors. The calculated CAGR (Compound Annual Growth Rate) is based on hypothetical values and should not be construed as an assurance or guarantee of future performance.

Key Points to Remember About CAGR:

  • CAGR Represents an Average: It does not reflect the actual year-to-year volatility of the investment.
  • Time Period is Crucial: The CAGR is specific to the analysis period. Different time frames will likely yield different results.
  • Not a Predictor of Future Performance: Past CAGR is not a guarantee of how an investment will perform in the future.

In Conclusion:

CAGR is a metric for investors seeking to understand the average annual growth rate of their investments over a specific period. By providing a smoothed perspective on performance, it aids in effective evaluation and comparison of different schemes. Utilizing CAGR can help investors gain a clearer understanding of their investment performance.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Please note that this article or document has been prepared on the basis of internal data/ publicly available information and other sources believed to be reliable. The information contained in this article or document is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party in any manner. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article or document.


Published on Apr 30 2025

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