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Compound Annual Growth Rate (CAGR) shows the mean rate of return that an investor has earned on his or her investments during a specified period of time exceeding one year. The rate is calculated in terms of annual percentage.

A single stock or mutual fund does not provide you a constant rate of return every year. The rate of may change from year to year. Furthermore, if you make repeated investments, you need to know the return earned on all the investments combined. CAGR makes it easier for investors to ascertain that single rate of return that covers every amount of investment throughout the period.

How is CAGR calculated?

To calculate CAGR, you would have to consider the amount of investment made in the initial year (the first year of investment), the amount of investment in the current or present year and the tenure of investment. Let’s have a look at the following example to make the process clearer:

The formula for CAGR is:

CAGR

Say, the price of a stock you invested in 2015 was ₹100. It appreciated by 25% to ₹125 in the year 2016 and further appreciated to ₹150 in the year 2017. Therefore, the appreciation in the rate from 2015 to 2017 was 20%. But in case, you want to know that one growth rate of your investments for the complete period of time, CAGR is there to help you. If we put the above values in the formula, Compound Annual Growth Rate for your investment between 2015 and 2017 will be 14.47%.

Why should CAGR be considered when looking at mutual fund returns?

When you make investments in a portfolio for more than a year, the concept of compounding interest comes into the picture. CAGR is generally used when the amount of money is compounded for many years. When you invest in a mutual fund, the growth rates that you see are not expressed in absolute returns, but CAGR.

Absolute returns, calculated in percentage, are calculated by subtracting the amounts of the beginning year and ending year and dividing it by the beginning year value.

CAGR tells the percentage of returns for a selected time frame, without highlighting the returns on investments for every single year. Mutual fund investors should consider CAGR while assessing their returns so as to see the complete returns earned. When we deposit money in mutual funds, or even FDs and PPF, we only know that it will fetch us 7% or 8% return every year. We never see how much returns we’d get in a period of 4 or 5 years. This is where CAGR helps.

The other types of returns, besides CAGR, that are used to analyse the performance of mutual funds are:

Annualized returns

Annualized return is defined as the geometric mean amount of funds that an investment creates every year for a fixed period of time. It signifies the rate of return that an investor would earn for a given period, considering the annual compounding of returns. Without focusing on the volatility of markets, such returns give a picture of how the investment would perform.

Trailing returns

For calculating the historical performance of your funds on daily, weekly, monthly or annual basis, the easy-to-understand technique of trailing returns should be used. If you invest an amount on 17th April 2017, the 1-month trailing return period will range from 17th April 2017 to 17th May 2017. Trailing returns might appear as you need to make the investment just once.

Return since launch

One can ascertain the value of Return Since Launch from the time an NFO (New Fund Offer) gets closed. It is calculated at an opening Net Asset Value of ₹10.

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