When you invest your money in a fixed deposit, you figure out how much you will invest, look for the best interest rates, and estimate your returns over a tenure. After all, it helps to know how much you will gain before locking your money in. So, why shouldn’t you be as well-informed while picking a mutual fund?
Mutual funds are heavily dependent on market fluctuations, so it isn’t as straightforward to anticipate their returns as you can with fixed deposits. But don’t worry! You can estimate a mutual fund’s returns using a metric called Compound Annual Growth Rate (CAGR).
If you have ever browsed mutual fund schemes, you will notice ‘CAGR’ written on your screen, along with a percentage value. What does this term mean to you, as an investor? Here is everything you need to know.
What is CAGR, meaning, in a mutual fund?
CAGR indicates how your investment’s value grows over a period of time. In other words, it shows you approximately how much your investment has earned each year over a given time interval.
CAGR is not the same as the annual growth rate of your investment. The annual growth rate is a simplistic, absolute value that indicates your mutual fund’s performance over a year.
On the other hand, CAGR depends on the total investment period. While calculating a CAGR, it is assumed that the same growth rate was compounded each year for the entire duration of your investment.
To understand this better, let us look at how CAGR is calculated. Later in the article, we will also compare CAGR and annual growth rates.
Additional Read – How are Mutual Funds Returns Calculated?
How to calculate CAGR?
The Compound Annual Growth Rate (CAGR) formula is as follows:
CAGR= (final value/initial value)^(1/n)-1
- ‘final value’ is the value of your investment at the end of the investment period
- ‘initial value’ is the value of your investment at the beginning of the investment period
- ‘n’ is the number of years for which you have invested
Suppose you invested Rs. 20,000 in a mutual fund scheme. After five years, your money grows to Rs. 36,000. Let us calculate the CAGR:
CAGR = (36000/20000)^1/5 – 1 = 12.47%
Simply put, your investment in the mutual fund has given you an average return of 12.47% every year.
CAGR vs annual growth rate
Let us assume that your mutual fund’s growth looks like this:
As an investor, if you gauge the worth of the fund with the annual growth rate between 2017 to 2018, you may think that the fund is performing poorly. But, looking at the 5-year CAGR, you can see the average yearly growth rate of your investment, which is 12.47%.
For investors, the CAGR is a more detailed and accurate metric. So, before you invest, use a CAGR calculator for mutual funds.
Additional Read – What Are the Average Returns on Mutual Funds?
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