Compound annual growth rate (CAGR)

Importance of CAGR:

CAGR is useful in many ways. It helps investors compare their performance to benchmarks, providing important insights. It also shows steady growth, which helps assess risk. Moreover, CAGR can predict future performance, helping in long-term decision-making.

Key benefits of CAGR:

To measure mutual fund performance, CAGR is essential. It shows growth over time, allowing for easy comparisons. Unlike simple averages, it focuses on long-term growth. CAGR smooths out short-term market ups and downs, offering a clearer view. It also considers reinvested returns, giving a full picture.

Examples:

Formula to calculate CAGR is,

CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) -1.

 

For example, if you invested ₹50,000 in a mutual fund five years ago, and it grew to ₹80,000, the CAGR would be about 12.47%. This means your investment grew by 12.47% each year on average. This is despite variations in actual year-to-year returns.

Benefits:

Comparing mutual funds can be tough. CAGR makes it easy. It shows fund performance in a clear manner. So, you can evaluate them quickly. Moreover, CAGR focuses on long-term growth. This helps avoid chasing short-term market spikes. It protects your investments. Additionally, CAGR aids in building a stronger portfolio. It highlights the best funds, guiding better choices. With CAGR, you can navigate mutual funds confidently.

Challenges:

• Ignores Volatility: While CAGR smooths out returns, it can mask the volatility or risks involved in an investment. It shows a consistent growth rate but does not reflect the potential for sharp rises or drops in value over time.
• Doesn’t Show Timing of Returns: CAGR shows the average growth over time but doesn’t indicate when the returns occurred. Significant returns in the last year of the period, for example, would look the same as consistent growth throughout the period.
• Not for Short-Term Investments: CAGR is better suited for long-term investments. It may not provide useful insight for short-term investment strategies, where market fluctuations play a significant role.

Useful tips:

Maximise your mutual fund CAGR with these proven strategies. First, leverage time's power by investing early, allowing compounding to work its magic. Next, boost returns by 1-1.5% through direct plans, avoiding unnecessary brokerage fees. Finally, balance risk and reward. Diversify across fund types and asset classes. To grow your mutual fund, use a trio approach. Start early, make direct plans, and diversify.