Business

What is the CAGR of a mutual fund? Is it important for investors?

NFL 3 years ago 3 min read

Regardless of whether you are new to mutual funds or have been investing in them for a while, you must have come across the term CAGR several times. CAGR is a commonly used term in the world of investing that is often used to describe a fund’s performance. To know what this term entails and how you can use it to make better investment decisions, you must understand how it is calculated. Read on to know more.

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What is CAGR, and how is it calculated?

The power of compounding is the primary reason for the success of mutual funds. Compounded Annual Growth Rate (CAGR) is a parameter that helps you understand how your investment is compounded. CAGR is the compounded growth rate of the money you invest in mutual funds. It is used to understand the average growth of a mutual fund scheme per year over a period of time.

Here’s how you can calculate CAGR. First, you must have the following three values:

The amount of investment you made in the first year (Begining value)
The value of your investment at the end of the year (Ending value)
The tenure of your investment (T)

Then, you put these variables in the following formula of CAGR:

CAGR = [(Ending value/ Beginning value) x (1/T)] – 1

Let’s consider a scenario where you invested Rs. 1,000. The return on your investment in the first year was Rs. 1250. The next year, it further increased to Rs. 1500. This implies that there was a 50% growth in your investment in two years. Using the above formula, the CAGR of your investment in a two-year period is 22.47%.

What is the importance of CAGR for investors investing in mutual funds?

Here are some ways in which the CAGR can help you:

CAGR can be used to find out the rate at which your investment grows every year. This can be useful to understand how your money has fared throughout the investment term.
CAGR can be used to compare the returns from different funds. This helps you make the right choice.
CAGR is a brilliant way to calculate the historical returns of a particular investment.

What are the limitations of CAGR when investing in mutual funds?

There can be certain limitations with CAGR, such as:

CAGR does not include the risk associated with an investment.
It also does not show you the market volatility of an investment.

To sum it up

While the CAGR may not present a conclusive image, it does play an indispensable role. Other parameters that can be used to gauge the performance of mutual funds include Extended Internal Rate of Return (XIRR) and absolute returns. It may be advisable to consider these together to know how your investments fare and make better decisions.

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