What is the CAGR In a Mutual Fund | Motilal Oswal

What is the CAGR In a Mutual Fund




If you are asking the question, “What is the CAGR?” you should know that it stands for compounded annual growth rate. With this measure, it is possible for you to compute and compare the profitability of companies over a span of time. The CAGR is usually used to make comparisons of companies related to performance indicators like revenue, sales, profits, and more. So, how does this relate to mutual funds? It does so in an important way, and you should know how, especially if you are considering mutual fund investment. 

What is the CAGR in a mutual fund?

Investing in mutual funds is a popular way to allocate your wealth and make returns in a stable way. As mutual funds invest your capital in diverse equity or debt, or a combination of both, depending on your risk appetite and distinct financial aims. You may open a Demat account and start investing in direct equity, but if you want to spread your investments, mutual funds are also worth looking into. When you invest in stocks of a particular company, you may want to know about the company’s performance relative to companies in the same league. This will give you an indication that the equity you are planning to invest in is worth your money. 

While investing in mutual funds, you invest in a bunch of stocks in a fund. On any mutual fund that you opt for, you hope for good gains from the performance of the fund. However, there is no way to guarantee a robust performance, as the saying goes, “mutual funds are subject to market risks” since they invest in equity. Therefore, returns from funds may fluctuate according to circumstances related to the market. So, this leads you to the burning question, “What is the CAGR in a mutual fund?”. It is vital to know how much of a return you can expect out of your fund, just so you can plan your investments in the future. The CAGR is a reliable metric to tell you about any mutual fund’s performance, at least, to a fair extent. 

CAGR - An Illustration

The CAGR in the share market lets you find out how much of your capital investment has increased. Simply put, the CAGR translates to the “compounded annual returns” expressed as a percentage. This shows the percentage of returns you have made out of your investment over a specific time period. For instance, let’s assume that you invested Rs. 1,00,000, and it increased to Rs. 2,20,000 in a period of 6 years. A common calculation of the absolute return can be made easily. This does not consider the duration of the investment. 

In this example, the return works out to 120% if you calculate returns according to a normal percentage formula. However, the CAGR is 17.08%. The absolute return may be a constant number, but the CAGR may change. This will be clearer when you understand the formula to compute the CAGR. 

How Do You Calculate CAGR?

What is the CAGR, and how do you make a calculation of it? You may have understood the first part of the question, but calculating it may pose a challenge. The formula for the calculation is: 

CAGR = (Value at the end of investment ➗ Value at the beginning of the investment) ^1/n-1

As an investor, you need not know this formula by heart, but as long as you know what the CAGR is, you can gauge your returns pretty easily. The beauty of the CAGR is that it considers the period of the investment related to your returns, and not just the absolute amount of return. This is an excellent way to account for any change in the value of an asset according to a particular period. As investment has as much to do with the time horizon as it has to with the amount you invest, the CAGR is a near-perfect way to estimate returns. 

What is the CAGR in a mutual fund

Whether you have the intention of subscribing to an upcoming IPO or a mutual fund, you may want to know about the returns you can expect from your investment. This helps you to opt for certain investments against others. In the case of a mutual fund, an investment may be worth your while if you can find a way to track it over a specified time horizon. If you examine a chart of a mutual fund’s performance, you may see different rates of growth over various time spans. This makes it a challenge to estimate the performance of a fund just based on the returns. 

Instead of this, if you could monitor the fund’s growth over a time period, you may find your job easier. This is where the CAGR is handy. It gives you a single growth rate, on an annual basis. Additionally, compound interest is also considered, making performance calculations more precise. In mutual funds, as with other investments, compound interest is vital in calculations. The CAGR is, thus, a popular measure in assessing a mutual fund’s performance. 

Some Estimation is Better than None

The CAGR, or the compound annual growth rate, is frequently used to assess the proficiency of a fund. When you wish to gauge a fund’s profitability in the long run, the CAGR is a good technique to employ. The CAGR gives you an appropriate measure of a company’s long-term potential despite any market volatility that may have impacted the company over a period. 

So, the CAGR gives good clues about a firm’s underlying prospects. When you open a Demat account, you may have a stock investment on your mind. While it is a good idea to have direct equity investment, mutual funds let you invest with some risk mitigation. You can also take into account any upcoming IPO to broaden your portfolio. Whatever investments you decide to have in your financial basket, the CAGR alone does not help you in decisions, but it is a good start to evaluate a mutual fund. 

 

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