Some time ago, we looked at what compounding is all about and how your money multiplies undercompounding. When money compounds over several years, the finance world use a simple metric called compounded annual growth rate (CAGR) that helps gauge the annual compounded returns of your investment, over several years. The returns that you see in your mutual funds for periods more than one year is CAGR. If you are wondering how CAGR is different from the usual absolute returns, do see the example below.

As seen above, returns up to one year remain the same whether it is absolute returns or CAGR. But look at the three-year period. The fund generated an absolute return of 85% in three years. Rs 1000 invested 3 years ago would be Rs 1850. In other words, your money almost doubled. Its CAGR is however only 23%.

CAGR simply tells you how the initial investment of Rs 1000 grew year-on-year to reach Rs 1850. Hence, a CAGR of 23% means an average return of 23% per year over the last 3 years. However, in reality, in those 3 years, your fund could have fallen in one year and run up steeply in another. CAGR simply normalises this to let you know the returns over the time frame you choose, irrespective of individual year performances were.

So why do we have to look at CAGR? The main reason to use this metric is to be able to compare returns across asset classes and other economy parameters like inflation and growth. For instance, whether you put your money in deposits for 3 years or 5 years, it is common parlance to say that it gives you an interest of say 8% per annum. You never say it gives 26 (absolute return)% for 3 years. The compounded annual rate makes it easier to compare. Similarly, when you look at an inflation number of say 7% annually and your fund has a CAGR of 23%, this gives you an indication that you are generating real returns over and above inflation.

Looking at the table above, a question might arise as to whether the three-year CAGR is greater than the five-year CAGR. True, over the above 5-year period, the rate of return may have been slower compared with the 3-year growth. This could be because the initial 2 of the 5 years may have been lacklustre. But it could be the reverse too. There could be periods when 3 year-returns appear lacklustre compared with 5 years as the last few years may have been volatile.

Hence, it may not be right to conclude from the above data that short-term returns are better than long term. The question is whether you will build more wealth by staying longer. And you certainly would have gained more, in the above case. Hence, instead of comparing returns across different time frames, simply use the data to compare returns for a given time frame across funds. The three-year returns of Franklin India Prima Plus for example, may be compared with say Mirae Asset India Opportunities.

Use CAGR as an effective tool to compare returns of a fund with its benchmark and its peers. It can also give you a sense of what sort of annual return the fund has delivered in the past and thus can be compared with other investment products.

Click to share on WhatsApp (Opens in new window)

Click to share on Facebook (Opens in new window)

Click to share on Twitter (Opens in new window)

Click to share on LinkedIn (Opens in new window)

Click to share on Reddit (Opens in new window)

Click to share on Google+ (Opens in new window)

Get FundsIndias articles delivered straight to your inbox!

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Outdated financial advice parents should avoid giving

What are the benefits of investing in mutual funds?

What is a mutual fund and why should you invest in it?

FundsIndia explains: When is it a good time to invest?

7 reasons why you should invest in Mutual Funds

FundsIndia explains: Closed-ended Fixed Income Mutual Funds

FundsIndia Explains: Why all equity funds arent the same

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

FundsIndia is Indias friendliest online-only investment platform. Built on robust technology, FundsIndia gives users access to mutual funds from leading fund houses in India, corporate fixed deposits, stocks from the BSE and various other investment products, all in one convenient online location. In short, FundsIndia is your one stop shop to build wealth.

Mutual fund investments are subject to market risks. Please read the scheme information and other related documents carefully before investing. Past performance is not indicative of future returns. Please consider your specific investment requirements before choosing a fund, or designing a portfolio that suits your needs.

Wealth India Financial Services Pvt. Ltd. (with ARN code 69583) makes no warranties or representations, express or implied, on products offered through the platform. It accepts no liability for any damages or losses, however caused, in connection with the use of, or on the reliance of its product or related services. Terms and conditions of the website are applicable.

Apple and the Apple logo are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc., registered in the U.S. and other countries.The Android robot is reproduced or modified from work created and shared by Google and used according to terms described in the Creative Commons 3.0 Attribution License.

AxisBaroda PioneerBirla Sun LifeBNP ParibasBOI AXACanara RobecoDSP BlackRockEdelweissFranklin TempletonHDFCHSBCICICI PrudentialIDBIIDFCIIFLIndiabullsInvescoJM FinancialKotak MahindraL&TLIC NomuraMirae AssetMotilal OswalPPFASPrincipalQuantumRelianceSBIShriramTataTaurusUTI

Tax Saving FundsDiversified FundsLarge-cap FundsMid & Small cap FundsInternational FundsSector FundsLiquid FundsShort-term FundsGold Funds

Bajaj Auto LtdJindal Steel & Power LtdNtpc LtdMaruti Suzuki India LtdTata Consultancy Services LtdTata Power Co.LtdOil And Natural Gas Corporation LtdHero Motocorp LtdTata Motors LtdItc LtdGail (India) LtdMahindra & Mahindra LtdIcici Bank LtdDr.Reddys Laboratories LtdTata Steel LtdWipro LtdState Bank Of IndiaSun Pharmaceutical Industries LtdHdfc Bank LtdHindalco Industries LtdHindustan Unilever LtdLarsen & Toubro LtdInfosys LtdHousing Development Finance Corp.LtdCoal India LtdBharti Airtel LtdBharat Heavy Electricals LtdCipla LtdReliance Industries LtdSesa Goa Ltd

FundsIndia is Indias friendliest online investment platform. Here, investors (resident Indians andNRIs) get access to a wide range ofMutual FundsEquitiesfrom theBombay Stock Exchange(BSE),Corporate Depositsfrom premium companies, and various other investment products in one convenient online location.

FundsIndia also offers a host of beneficial value-added services like free financial advisory services, flexible types ofSystematic Investment Plans(SIPs), trigger-based investing, Portfolio-level SIPs, SIP Designer, Value-averaging Investment Plans (VIPs), instant Portfolio X-rays, and so much more that further enrich an investors investment experience. Also, with Indias most complete automated advisory service, Money Mitr, investors can get great mutual fund recommendations for lump sum and SIP-investing automagically.

Registering with FundsIndia takes less than two minutes, what with theAadhaar-based eKYCsystem. This makes investing a paperless and hassle-free process, and FundsIndia the best investment platform in India.

Investing with a FundsIndia account is absolutely safe and secure. The platform is registered with entities such as the Association of Mutual Funds in India (AMFI), the Bombay Stock Exchange (BSE), theCredit Information Bureau Limited(CIBIL), the Central Depository Services Limited (CDSL), and the Central Insurance Repository Limited (CIRL).

FundsIndia also offers many resources that can help investors make the right investment decision before they invest online. Some of them are access to different types ofinvestment calculators, tax calculators to know how much you need to save intax-saving mutual funds(or ELSS) to benefit from exemptions, and so on.

Thus, FundsIndia is a one-stop shop for Indian investors whod like to invest in thebest mutual funds, buy shares or stocks online by opening ademat account, and whod like to get access to the best investment plans and different ways of investing through SIPs. Every investor with FundsIndia gets a dedicatedinvestment advisortoo, making FundsIndia a full-fledged financial advisory services portal for investors who aspire tobuild wealth.