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CAGR in Mutual Funds: What is CAGR in Mutual Funds Explained

9 Mins 13 Feb 2023 0 COMMENT

As an investor, one of the main objectives is to generate returns from investment and build wealth in the long run. One can choose many different investment options to park their money in. During the process of selecting a security to invest in, there are several factors that one needs to consider. Among them, there is one factor that can have a significant impact on the returns and your investing decision – CAGR.

What is CAGR in Mutual Fund?

Compounded Annual Growth Rate, also known as CAGR, refers to the rate at which an investment has grown over a period of one year. CAGR is related to the concept of compounding therefore learning about it can help us know what is CAGR in mutual funds.

Compounding refers to the phenomenon in which the interest or returns generated are reinvested and earn interest or returns as well. For example, an investment of Rs 1,000 generated returns of 10% in one year. The profit is Rs 100. If this profit is reinvested and the investment generates a return of 10% in the next year as well, then the profit will be Rs 110. Thus, we can say that the investment is growing at a CAGR of 10%. The longer an investor stays invested, the higher returns are generated with the power of compounding.

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How to calculate CAGR in Mutual Funds?

The calculation of CAGR will help us understand how CAGR in mutual fund affects the returns.

CAGR Formula:

CAGR = Ending Value 1/t – 1
Beginning Value

Ending Value = The value of the investment at the end of the period.

Beginning Value = The initial value of initial investment.

t = The number of periods for which the investment was made.

For example, an initial investment of Rs 3,000 was worth Rs 12,000 at the end of 4 years. With the help of the formula, we can find out the CAGR which is 41.42%. This means that the initial investment of Rs 3,000 grew at 41.42% per year.

Alternatively, one can make use of a CAGR calculator online to easily ascertain the CAGR of an investment.

Use of CAGR calculator in Mutual Funds:

• Used by investors as well as fund managers to know the performance and the returns that are being generated by the fund
• Used by Asset Management Companies (AMCs) to disclose the CAGR of their mutual fund schemes over certain years

Advantages of Compound Annual Growth Rate (CAGR):

There are several benefits of knowing what is CAGR in mutual funds

• An investor can calculate CAGR  to analyze a fund’s performance. CAGR helps an investor know how much return the fund has given in a particular period and helps monitor the growth rate of the fund.
• Historic data about the fund’s CAGR in past years can also help in knowing how the fund and investments made in the past have performed.
• CAGR is especially a helpful tool while comparing different funds. An investor would always want to invest in a security that provides higher returns. Therefore, CAGR can be a good metric to filter and compare similar funds.
• CAGR is also helpful in order to estimate what the future value of an investment might be. This can help while making financial plans and goals.

The popularity of mutual funds has been rising among retail investors. With several schemes available in the market, it can be tricky to select the right one. Knowing what is CAGR in mutual funds can help an investor compare and select a fund that helps them meet their financial goals and also track and monitor the growth of their investments.

Limitations of CAGR

Here are the limitations associated with CAGR:

Assumes Steady Growth: CAGR assumes that the investment grows at a steady rate each year. A CAGR of 12% may tell you the same. However, this is not the case in real-world scenarios. Market volatility and fluctuations can cause the actual returns of mutual funds to vary from the CAGR.

Not Suitable for Short-Term Evaluation: While CAGR is useful for evaluating long-term performance, it may not provide meaningful insights for short-term investment horizons. Short-term fluctuations in the market can distort the CAGR calculation and may not accurately reflect the fund's performance over a brief period.

Not ideal for SIP return calculation: Unlike lump-sum investments, where CAGR calculates the annualized growth rate over a specific period, SIPs result in investments being made at different intervals and varying market prices. CAGR does not account for these periodic investments and their impact on overall returns.

CAGR in Mutual Funds FAQs

CAGR in mutual funds is calculated by using the following formula:

CAGR = Ending Value 1/t - 1

Beginning Value

Is higher CAGR better?

Since a higher CAGR means that your investment will grow at a higher rate each year, it is considered to be good.

Can CAGR be used for SIP?

CAGR is not an ideal indicator for a SIP as you will need to calculate the CAGR after every instalment. CAGR is suitable for calculating the growth of lump sum investments.

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