CAGR vs Absolute Returns

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When analyzing mutual fund performance, investors commonly compare Compound Annual Growth Rate (CAGR) and absolute returns, as each provides different insights into investment growth.

What is CAGR in Mutual Funds?

CAGR, or Compound Annual Growth Rate, represents the average annual growth rate of an investment over a specific period, assuming all profits are reinvested. It helps track how an investment reaches its final value over time, offering a simplified view of fund performance. CAGR is particularly helpful for comparing different investments held over similar time frames.

CAGR Formula:

CAGR =  (Ending Value / Beginning Value) ^ (1 / n) - 1  x 100

Where:

• Ending Value = value of the investment at the end of the period

• Beginning Value = value of the investment at the start

• n = number of years the investment is held

Example: If an initial investment of ₹80,000 grows to ₹1,20,000 over 7 years:

CAGR =  (1,20,000 / 80,000) ^ (1 / 7) - 1  x 100 = 5.96%

What is Absolute Return in Mutual Funds?

Absolute return measures the total return on an investment over a specific period, indicating the percentage growth or decline from the initial investment to its current or ending value. Unlike CAGR, it does not consider the time period, focusing purely on the investment’s performance.

Absolute Return Formula:

Absolute Return =  (Current Value / Initial Investment Value) - 1  x 100

Example: For an investment of ₹50,000 that grows to ₹85,000:

Absolute Return =  (85,000 / 50,000) - 1  x 100 = 70%

CAGR vs Absolute Returns: Comparison Table

Parameters	CAGR	Absolute Returns
Objective	Reflects yearly growth, assuming reinvestment	Shows total growth or decline, regardless of time
Time Factor	Accounts for investment duration	Ignores investment duration
Accuracy	More accurate for comparing investments of different durations	Best for shorter-term investments
Best For	Longer-term investments (more than a year)	Shorter-term investments (less than a year)

Which is Better?

CAGR is generally preferred for long-term investments, as it reflects annualized growth, accounting for time. This makes it ideal for comparing investments over several years. On the other hand, absolute returns can be more suitable for short-term holdings where a straightforward measure of gain or loss is needed.

Bottomline

Both CAGR and absolute returns have unique benefits depending on investment duration. Absolute returns give an immediate view of growth, while CAGR shows a consistent annualized rate, aiding in long-term comparison. Investors should use both metrics for a more comprehensive understanding of their investment’s performance in alignment with their financial goals.

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