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What is CAGR
Compound Annual Growth Rate (CAGR) is a calculation used to estimate an investment’s average yearly growth over a selected time period. It provides an estimate of the average rate of return one can earn from an investment every year. CAGR is mostly used by investors to get an accurate measure of their investment growth over time.
How to calculate CAGR?
CAGR is the rate of return required for an investment to attain growth from its initial value to the maturity value. While using CAGR, it is assumed that the profits from the investment are reinvested at the end of each investment period.
CAGR can be estimated using the following formula:
CAGR = [(Maturity value/Initial Value)^(1/N)]-1
Let’s understand this formula with the help of an example
If the beginning value of an investment is Rs. 10,000 and its ending value is Rs. 14,000 over a span of 2 years, CAGR will be:
CAGR = [(14,000/10,000)^(1/2)] -1 = 18.32%
How does Fisdom’s CAGR calculator work?
The CAGR formula in Fisdom’s CAGR calculator is dependent on three key variables:
- The beginning value
- The ending value
- Number of years (N).
Once a user enters the three variables, the CAGR calculator shows the rate of return on the investment. Users can also estimate the absolute return on investment through the CAGR calculator. The formula for absolute return is:
(Maturity value – Start value)/Start value * 100
How to use the CAGR calculator
In today’s digital age, where internet banking and online investments are commonplace, online calculators like CAGR can come in handy. Finity has designed a simple and easy-to-use online CAGR calculator to help investors calculate the Compound Annual Growth Rate on their investments.
To use this calculator, a user simply has to select the rate of return of choice and input the necessary details. Here is how:
Step 1: Plug in or select the initial investment amount from the slider bar
Step 2: Enter the final investment amount
Step 3: Enter the investment duration in years
Once all the three values are plugged in, the calculator will automatically calculate the CAGR in percentage format on the right-hand side.
How can Fisdom’s CAGR calculator help investors?
An investor can use the Finity CAGR calculator to ensure that they make the right investment decisions. It helps in determining the annual rate of return of an investment. Once the investor knows the CAGR results, it is easy to compare the returns from the investment against a chosen benchmark to further analyse the investment decision.
The CAGR calculator can help new investors in estimating the returns from a mutual fund investment. They can then compare the mutual fund’s average annual growth rate against a benchmark over a selected period. This allows better decision making, since one can choose a mutual fund scheme based on past returns.
With CAGR calculator, investors can also compare the performance of stock investments against peers within the industry. CAGR can also be used to determine how investments within a portfolio have been performing over a chosen period.
How to compare investments using CAGR?
CAGR is considered as one of the accurate methods of calculating and estimating investment returns, especially for investments whose value has changed over time. Investors can compare 2 investment options of a similar nature or belonging to the same market index using CAGR. It tells how one investment has performed in
comparison to the other belonging to the same category and through the same time period.
Benefits of CAGR calculator
Here are some benefits of using a CAGR calculator:
- The CAGR calculator is a straightforward utility application that can help you figure out how much your mutual fund assets are worth.
- The compound annual growth rate may also be used to compare stock performance to that of peers or the industry as a whole.
- The CAGR may be used to assess how your portfolio’s investments have performed over time.
- The CAGR calculator is a useful tool for anyone who wants to estimate the gain from an investment.
- If you know how to calculate the growth rate, you can determine the profit of your investment over a particular period.
What are the limitations of the CAGR concept?
Although CAGR is very useful in investment decisions, it has certain drawbacks. Here are the key limitations to know before using the CAGR calculator:
- CAGR calculations take into account the start and end values while assuming that an investment grows constantly throughout its duration. It ignores the fact that investments can experience volatility and therefore their growth may not be uniform.
- CAGR ignores the risk involved in any investment. In certain investments, such as equities, it is important to focus on risk-adjusted returns rather than CAGR.
- While the CAGR calculator can be used to determine returns from lump-sum investments, investors of SIP investments may not be able to use the same. This is because the periodic investments made in SIPs are not taken into account as the calculation concentrates on the beginning value of investment.
Here’s an example that might be more relevant to someone interested in stock markets in India:
Let’s say you invested Rs. 10,000 in a stock. After one year, your investment has grown to Rs. 12,000. After two years, it has grown to Rs. 15,000.
To calculate the CAGR over the two-year period:
- First, divide the ending value of the investment by the beginning value: Rs. 15,000 / Rs. 10,000 = 1.5
- Next, raise that result to the power of 1/2 (since there are two years in this example): 1.5^(1/2) = 1.2247
- Finally, subtract 1 from that result: 1.2247 – 1 = 0.2247
CAGR can be useful for comparing 2 investment alternatives, however, since it does not account for the risk element, an investor cannot consider the associated risk in both alternatives. Since CAGR is not risk-adjusted, it may not reflect the holistic overview of an investment.
It is advisable to use CAGR wisely and to account for the risk adjustment before taking any investment decisions.
In general terms, a CAGR between 15-25% over a 5-year horizon can be considered a good return on investment. This is especially applicable to stocks and mutual fund investments.
Fisdom’s online CAGR calculator is absolutely free and does not involve any charges for usage.
CAGR is preferred over IRR for investment performance measurement since the former indicates overall financial health and provides an indication of investment stability.
CAGR tells us the rate at which an investment can grow over time. If an investment is growing at 10% CAGR, it means that the average annual growth of that investment is 10%.
he usage of CAGR or AAGR (annual average growth rate) is dependent on the purpose. Calculating CAGR is often more viable, whereas AAGR is a linear measure that doesn’t account for the compounding effects and therefore it can be misleading at times. CAGR smoothes out the market volatility impact on periodic returns.