What is CAGR?
CAGR refers to the mean annual growth of an investment over a specific time duration. The value of the investment is assumed to be compounded over the period. Unlike the absolute return CAGR takes the time value of money into account. As a result, it can reflect the actual returns of an investment generated over a year.
The CAGR can be calculated using the following mathematical formula:
CAGR = [(Ending value/Beginning Value)^(1/N)]-1
The above formula depends on three variables, namely, the beginning value, the ending value, and the number of years (N).
When you input the above three variables, the CAGR calculator will give you the rate of return on investment.
For example, if you had a beginning value of investment of Rs.1,000 and the ending value of investment of Rs.4,000 over two years, then your CAGR would be 100%.
CAGR = [(4000/1000)^(1/2)] -1
How To Use CAGR Calculator
CAGR calculator is an easy tool to use and analyse your investment decisions. It finds application in the following scenarios:
1.You bought some units in equity funds this year, and your fund value has increased. With the help of CAGR calculator, you would be able to know the rate of return on your investment.
2. A CAGR calculator allows individuals to calculate the compounded annual growth rate of their investment over a period. To obtain the CAGR value, you need to enter the beginning value along with the anticipated ending value and the number of years over which you would like to calculate the CAGR. The calculator will display the CAGR value.
3. CAGR of a mutual fund can be compared with a benchmark return to know if it’s doing good in the market.
4. CAGR of a mutual fund can be compared with a benchmark return to know if it’s doing good or bad in the market
Limitations of CAGR
Even though CAGR is a useful concept, it has many limitations. A lack of awareness of these limitations would lead to wrong investment decisions. The following are some of the restrictions of CAGR calculators:
In calculations related to CAGR, it’s only the beginning and ending values. It assumes that growth is constant over the duration of time and does not consider the aspect of volatility.
It is suitable only for a lump sum investment. As in the case of SIP investment, the systematic investment at various intervals will not be considered as only the beginning value is considered for the calculation of CAGR.
CAGR does not account for the risk inherent in an investment. When it comes to equity investment, risk-adjusted returns are more important than CAGR. For these purposes, you need to consider better ratios like the Sharpe ratio.