CAGR means Compound Annual Growth Rate. It is a measure of an investment's performance over a given period of time.
A higher CAGR generally indicates better historical returns when comparing investments over the same time period.
For example, if Fund A has delivered a CAGR of 20% over two years while Fund B has delivered 15% over the same period, Fund A has generated higher average annual compounded returns.
CAGR formula
CAGR = ((Final Investment Value / Initial Investment Value)^(1/t)) − 1
where t = number of years.
The result is expressed as a percentage (%).
Real-Life Example of CAGR Impact
I invested ₹2,50,000 in one of my mutual funds and did not make any additional investments or withdrawals during the next 2 years.
At the end of the 2-year period, the value of the investment had grown to ₹2,65,000. Using the CAGR formula:
CAGR = [(₹2,65,000 ÷ ₹2,50,000)^(1/2)] − 1 = 2.96% per year
This means my investment grew at an average compounded annual rate of approximately 2.96% per year over the two-year period.
Importance of CAGR as an Investor
- CAGR helps you compare funds over the same time period based on their historical returns.
- CAGR does not guarantee future returns. If a fund has a higher CAGR than another fund, it does not guarantee that the fund will continue to outperform in the future.
- CAGR does not account for multiple investments or withdrawals made during the investment period. In such cases, XIRR provides a more accurate measure of returns.
- CAGR also does not account for the type of fund category, investment strategy, or market volatility.
- CAGR can be used along with important performance comparison tools like XIRR to better understand and evaluate the performance of a fund.
- CAGR is an important performance parameter, but it is not the sole parameter for assessing the performance of mutual funds.
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