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“Compound interest is the eighth wonder of the world. He who understands it earns it … he who doesn’t … pays it.”

– Einstein

This timeless statement is one of the driving forces behind wealth-building and tax-saving investment schemes. Exploiting the power of compounding is no rocket science – all you need is some necessary information and financial discipline. Let’s see how the Compound Annual Growth Rate (CAGR) can drive your financial goals to fulfilment and mega wealth. We have covered the following in this article:

Compounded annual growth rate (CAGR) is one of the most commonly used terms in the mutual fund industry. CAGR represents the compounded growth rate of your investments made in mutual funds. It helps you gauge a mutual fund scheme’s average annual growth over a given time period.

A single stock or a mutual fund do not provide you with a constant rate of return every year. The rate varies from year to year. If you reinvest, then you need to know the profit earned on all the investments together. For instance, say you have invested in ELSS with a five-year tenure. CAGR tells you the extent of return a fund provided you every year during this period. However, this is applicable only if you reinvest your gains every year.

Most investors rely on absolute returns to analyse the performance of their investments. However, it does not consider the time value of money. On the other hand, CAGR takes into account the period for which you stayed invested in the given avenue. It gives you an approximate rate at which your investment would grow if there is no volatility.

It is an excellent way to factor the fluctuations experienced by the asset over a specific period. Then, you may easily interpret its performance over the particular horizon. It is one of the excellent means to gauge how a given investment fared as compared to its price.

You can calculate CAGR in three easy steps. You must know these three numbers:

- The investment made in the initial year (the first year of investment)
- Value of investment at the end of the year
- Tenure of investment You can calculate CAGR using our CAGR Calculator as well.

Let’s have a look at the following example to understand the same better: The formula for CAGR is:

For example, imagine you bought a stock at Rs.100 in 2015. It appreciated by 25% to Rs.125 in the year 2016 and further appreciated to Rs.150 in the year 2017.

Therefore, the appreciation in the rate from 2015 to 2017 was 50%. If you want to know the growth rate of your investments for the entire period, use CAGR. If we put the above values in the formula, Compound Annual Growth Rate for your investment between 2015 and 2017 will be 22.47%.

In case of an investment avenue like mutual funds, you need to ascertain whether it’s worth investing or not. For that, you require means to measure its performance over a given period. Mutual fund fact sheet would give growth rates across different time horizons of the fund. It may not be easy to judge the fund performance based on multiple rates.

Instead, if you could know how it has grown annually, then things may get simpler. This is where CAGR will help by providing you with a single annual growth rate. Apart from this, it also brings compound interest to the picture. Most investment avenues, including mutual funds, use compound interest to compute returns. So, CAGR would be the right way to measure fund performance.

- The CAGR is not an indicator of sales that happened from the starting year to the last year. In some cases, entire growth may be concentrated in the initial year or at the end of the year.
- Sometimes, two investments may reflect the same CAGR, with one being more lucrative than the other. This could be because the growth was faster in the initial year for one, while the growth happened in the last year for the other.
- They usually employ CAGR for investment periods ranging from three to seven years. If the tenure is more than, say, ten years, then the CAGR may hide the sub-trends in between.
- Remember, Compound Annual Growth Rate is different from year-on-year (e.g., return on 21 March 2019 vs that on 21 March 2020) growth rate

There are other types of returns, besides CAGR, that are useful in analysing the performance of mutual funds.

**Annualised returns**It is the geometric average amount of funds that investment creates every year for a fixed period. Annualised returns signify the return rate an investor earns for a given period, considering the annual compounding of returns. This provides clarity on how the investment would perform without focusing on the market volatility of markets.**Trailing returns**This is useful for calculating the historical performance of your funds on a daily, weekly, monthly or annual basis. Trailing returns method is perfect for a one-time investment. If you invest an amount on 17 April 2019, the 1-month trailing return period will range from 17 April 2019 to 17 May 2019.**Return since launch**One can ascertain the value of return since launch from the time an NFO (New Fund Offer) gets closed. They calculate it at a first Net Asset Value of Rs 10.

**Conclusion:** In a nutshell, in spite of other methods, CAGR is far more reliable to track the growth of an investment. This is mainly because the annual return rate doesn’t consider the compounding factor, leading to overestimation. Thus it is useful to understand how a mutual fund grows in terms of CAGR and use it to compare different funds. If such in-depth research is not for you, then you can invest in our hand-picked mutual funds from the country’s top fund houses.

As a tax-paying citizen, Section-80C of the Indian Tax Act allows you some breather a deduction of up to 150,000 from your total annual income.

CAGR or Compound Annual Growth Rate gives you the investments annual growth rate over some period of time. You may consider CAGR as a percentage-based metric, which helps you determine the annual rate at which your investment grows over a period of more than one year. You may use CAGR to determine the exact percentage of the returns from your investments each year, across the investment tenure.

CAGR = [(Ending Value/Beginning Value) ^ (1/N)]-1

For example, the initial value of your investment is Rs 10,000, and the final value is Rs 15,000 in three years (N= 3 years). CAGR is calculated as:

CAGR = (15,000/10,000)^(⅓) – 1

CAGR = 14.47%.

You may measure the performance of mutual funds using CAGR. You get to know the average annual growth of a mutual fund or even the decline, over a specific time period.

For example, you invested Rs one lakh in XYZ mutual fund in 2015. The NAV of XYZ mutual fund was Rs 20 and you got 5,000 units. You have redeemed all these units at the end of three years at a NAV of 25. Your mutual fund investment has a value of 5000 * 25 = Rs 1,25,000.

CAGR of mutual funds = (1,25,000/1,00,000) ^ (⅓) – 1 = 7.72%.

You may use the Compound Annual Growth Rate or CAGR to determine the performance of your stock investments over a set period of time. You get an idea on how much your stocks have gained or lost each year.

For example, you have bought 200 shares of XYZ at Rs 100 in the year 2016. You have sold all the 200 shares in the year 2018 at Rs 150.

CAGR of stocks = (30,000/20,000) ^ (½) – 1 = 22.47%.

CAGR or Compound Annual Growth Rate shows the actual return from an investment. However, CAGR is popularly used to gauge return from mutual funds and stocks and not so much for banking. You may consider annualised yield in banking instead of CAGR. It is the interest you receive in a year over the total investment you make.

You may consider CAGR to be accurate when you make a one-time investment. However, you may invest in mutual funds through the systematic investment plan or the SIP.

You would find the earnings percentage to be different for each tenure of the investment and CAGR fails to show the accurate earnings percentage over cumulative investment tenures.

You may consider XIRR for multiple investments made with the same SIP over the investment tenure. In simple terms, XIRR is an aggregation of multiple CAGRs.

CAGR shows you the mean annual growth rate of your investments over a period of time which is above one year. It is an accurate way to determine return on individual assets and investment portfolios, which may rise and fall over some time.

You can understand the calculation of CAGR with an example. Suppose you had invested Rs 1,00,000 in Company XYZ for 5 years. The valuation of the company rose and fell in the five year period.

You can understand the calculation of CAGR with an example. Suppose you had invested Rs 1,00,000 in Company XYZ for 5 years. The valuation of the company rose and fell in the five year period.

Suppose the valuation in the first year was Rs 75,000, the valuation in the second year was Rs 1,00,000, the valuation for the third year was Rs 1,50,000, the valuation for the fourth year was Rs 1,25,000 and the valuation for the fifth year was Rs 2,75,000.

You may calculate the CAGR of your investment in the Company as follows:

CAGR = (End Value)/(Beginning Value) (1/n)-1

CAGR (Compound Annual Growth Rate) = (2,75,000)/(75,000)^(⅕) – 1

CAGR = 29.67%.

You may consider CAGR of around 5%-10% in sales revenue to be good for a company. It is used to forecast the growth potential of a company. You may calculate CAGR for a company using the formula:

CAGR = 1+ ((Return on Investment)) ^ (365/Days) -1

Return on Investment = (Revenue – Costs)/(Costs)

You may consider an absolute return as the increase or decrease of an investment over a given time period, expressed in percentage terms.

You may calculate the absolute return for an investment using the following formula:

(End Value – Beginning Value) / (Beginning Value) * 100

For example, an investment of Rs 10,000 in May 2015 has appreciated to Rs 18,000 in May 2018. The absolute return is given as:

Absolute Return = (18,000 – 10,000) / (10,000) = 80%

You may consider CAGR to be an imaginary number which shows you the rate at which the investment would have grown. Using the above example:

CAGR = (End Value)/(Beginning Value) (1/n)-1

CAGR = (18000)/(10000) ^ (½) -1

CAGR = 34.16%.

You may consider CAGR of around 5%-10% in sales revenue to be good for a company. CAGR is used to forecast the growth potential of a company. For a Company with a track record of over five years, you may consider a CAGR of 10%-20% to be good for sales.

You may consider an annualised return to be standardised return computed as a percentage per annum.

Annualised Return = (End Value – Beginning Value) / (Beginning Value) * 100 * (1/holding period of the investment)

Annualised return is an extrapolated return for the entire year. CAGR shows the average yearly growth of your investments.

You may consider CAGR to be a geometric progression ratio. You may find CAGR to be a popular financial ratio which helps you compare the return from different investments.

The CAGR Ratio shows you which is the better investment by comparing returns over a time period. You may select the investment with the higher CAGR Ratio.

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

For example, an investment with a CAGR of 10% is better as compared to an investment with a CAGR of 8%. (All other parameters being equal).

Rolling returns give you the performance of investments across all time scales. It is the average annualised return for a time period. It measures returns from investments at different points in time eliminating the bias you may see from returns observed at a particular point in time. However, CAGR hides volatility by smoothening the performance of the investment.

a. You may calculate CAGR using the formula:

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

For example, you purchased mutual fund units at an NAV of Rs 11. You redeemed the investment at Rs 13.5 after 450 days. Let’s calculate the CAGR.

CAGR = (13.5) / (11) ^ (365/450) – 1

CAGR = 18.07%.

b. You may calculate CAGR using the **ClearTax CAGR Calculator**. You just enter the initial value of the investment and the final value of the investment. You then enter the duration or time period of the investment. The ClearTax CAGR Calculator shows you the CAGR of your investment.

c. CAGR shows you the smoothened average annual return earned by your investment each year. It is a pro forma number which gives you an idea of investment yield on the annually compounded basis. CAGR shows you the geometric mean return of your investments over a time period, also accounting for compounding growth. In simple terms, an investment with a higher CAGR is better as compared to a lower CAGR. (All other parameters being equal)

Yes, you may calculate CAGR even if one number is negative. You may consider the following example to get a better understanding. Take a look at the table below which shows the Year and the Revenue of Company XYZ.

Year | Revenue (Rs) | Annual Growth Rate (%) |
---|---|---|

2010 | 1000000 | |

2011 | 1200000 | 20 |

2012 | 1100000 | -8.333333333 |

2013 | 1500000 | 36.36363636 |

2014 | 1700000 | 13.33333333 |

2015 | 2200000 | 29.41176471 |

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

CAGR = (22,00,000)/(10,00,000)^(⅕) -1 **CAGR = 17.08%.**

You may calculate CAGR using the XIRR function in Excel. You could understand this with an example.

Suppose you invested in a mutual fund on 21 July 2012 at an NAV of Rs 10.26. You want to know the return on 02 January 2015 when the NAV was Rs 39.71. Here’s how to calculate CAGR using the XIRR function in Excel.

Date | NAV |
---|---|

21-Jul-12 | -10.26 |

02-Jan-15 | 39.71 |

XIRR | 0.736593 |

You may choose the values and dates in the XIRR function.

You may collect data on the sales revenue of a company from the balance sheet. You may consider the following example where you have the sales revenue of a company XYZ taken from the balance sheet.

Year | Sales in Crores (Rs) |
---|---|

2010 | 100 |

2011 | 110 |

2012 | 90 |

2013 | 120 |

2014 | 150 |

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

Ending Value = 150

Beginning Value = 100

Number of Years = 5

CAGR = 8.44%

You may calculate the final or end value from the CAGR using the reverse CAGR formula.

FA = final or end amount

SA = starting amount

N = Period in years

For example, you have a CAGR of 15%, Starting amount of Rs 1 lakh and time period of 5 years.

FA = 1,00,000 * (15/100+1) ^ 5

FA= 2,01,136. **You may calculate the end value using excel in the following way:**

You may calculate CAGR online using the **ClearTax CAGR Calculator.**

- You may consider entering the initial value and the final value of your investment.
- You then fill up the number of years of investment.
- The ClearTax CAGR Calculator shows you the compound annual growth rate or CAGR.

You may consider calculating the CAGR of your SIP investments in mutual funds.

You may find XIRR accounting for multiple investments in the same SIP across a particular tenure. It treats multiple SIPs as the same investment.

Let us understand CAGR in SIP with an example. Suppose you start an SIP in a mutual fund scheme at Rs 500 for 12 months. You have received Rs 6,500 at maturity.

You may consider CAGR to be 15.67%.

You may use CAGR to gauge the performance of different mutual funds to determine the earning potential. CAGR may consider the investment tenure giving you an accurate picture of the earnings from your mutual funds.

You may use CAGR to compare the historical returns of bonds, stocks or mutual funds. It helps you gauge the returns from your investments over the entire investment tenure.

CAGR eliminates the effects of volatility on periodic investments. You may use CAGR to determine the performance of an investment over a time period of around three to five years. CAGR shows the geometric mean return while also accounting for compound growth. CAGR helps you calculate the internal rate of return of your investments.

You don’t consider the investment tenure when determining the absolute return. You would only consider the initial investment and the final amount.

For example, if you invested Rs 1,000 in the past and today the value of the investment is Rs 1,500 then you have earned an absolute return of 50%.

Absolute Return = (1500-1000)/1000 * 100 = 50%

You may consider the investment tenure when calculating CAGR. Taking the same example, suppose you have an investment tenure of two years.

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

CAGR = (1500) / (1000) ^ (½) – 1

CAGR = 22.47%.

You may consider IRR and CAGR for different purposes. CAGR shows you the return from your investment over a time period. However, you could use IRR to determine the return from complicated projects and investments with different cash inflows and outflows.

IRR and CAGR are the same when you make a lump sum investment. However, they would differ when you make multiple investments and you have variable annual returns. In a nutshell, you may use IRR to determine the return from your investments with multiple cash flows.