When you’re investing in mutual funds, understanding the progress is very important. To measure it there are two widely used metrics Absolute Returns and CAGR (Compound Annual Growth Rate) which aids quantify this increase. Both these measures are different but they indicate the amount of profit your investment has generated.
In this article let’s understand everything you should know about CAGR and Absolute Returns
What does mutual fund CAGR mean?
The Compound Annual Growth Rate specifies the average annual growth rate of your investment over time. It assumes that your earnings are reinvested annually.
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CAGR Formula:
CAGR = ((Ending Value / Beginning Value)^(1/Number of years)) - 1
Where:
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Final Value – Value of your investment at the end.
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Initial Value – Value of your investment at the start.
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n – Number of years the money was invested.
Example:
In a mutual fund, if you invested ₹1,00,000 and its value increased to ₹1,50,000 in 3 years, then the CAGR would be:
CAGR = (150,000/ 100,000)^(1/3) - 1 = 14.47%
This means your money raised by about 14.47% every year for 3 years.
Benefits of CAGR:
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Shows the average annual growth of your investment.
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Helps compare the performance of different mutual funds.
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Good for checking long-term returns.
Limitations of CAGR:
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It assumes the growth is steady, which may not always be true.
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It does not show ups and downs in the market.
What is Absolute Return in Mutual Fund?
Absolute Return tells you how much your investment has grown in percentage over a period. It is the simplest way to calculate returns and does not consider the time period.
Absolute Return Formula:
Absolute Return = [(Current Value - Initial Investment) / Initial Investment] * 100.
💡 Example:
If you invested ₹1,00,000 in a mutual fund and its value grew to ₹1,50,000 after 3 years, the absolute return would be:
Absolute Return = [(150,000 -100,000) / 100,000] * 100 = 50%
This means your investment increased by 50% in 3 years.
Benefits of Absolute Returns:
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Simple and easy to calculate.
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Gives a quick idea of total growth.
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Useful for short-term investments.
Limitations of Absolute Returns:
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Does not show how long it took to get that return.
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Not suitable for comparing long-term investments.
CAGR vs Absolute Returns: Key Differences
When Should You Use CAGR or Absolute Returns?
Use CAGR when:
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You want to check the performance of a fund over a long period.
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You are comparing the growth of multiple mutual funds.
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You want to know the average growth of your investment.
Use Absolute Returns when:
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You want to see how much your investment has grown in total.
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You are checking the performance of a short-term investment.
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You are looking at returns for less than a year.
Why is CAGR Better for Long-Term Mutual Fund Investments?
For long-term investments, CAGR gives a better idea of how your money is growing. Since mutual funds go up and down in value, CAGR shows a smooth average growth. It helps investors understand how well a mutual fund performs over time.
Why Absolute Returns Can Be Misleading for Long-Term Investments?
If you use absolute returns to check long-term performance, it may give a wrong impression. For example, a 50% return over 5 years might look good, but it does not show whether the returns were consistent or came only in the last year. CAGR shows a better picture by considering the time period.
CAGR and Absolute Returns in SIPs: What You Should Know
If you invest using SIPs (Systematic Investment Plans), CAGR is a better metric. It considers the growth of all your investments over different time periods. Absolute returns may not show the correct picture because SIPs involve multiple investments over time.
How to Use CAGR and Absolute Returns for Better Investment Decisions?
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Compare Funds: Use CAGR to compare different mutual funds over a period. A higher CAGR means better performance.
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Check Short-Term Gains: If you’re investing for a short time, check absolute returns for quick insights.
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Plan for the Future: To estimate future returns, use CAGR to plan long-term goals.
Conclusion
Once we are aware of what CAGR and Absolute Returns do in mutual funds, it’s easier to make knowledgeable investment decisions. Absolute returns lead to easier and effortless analysis but CAGR offers a more practical view of long-term investments.
When looking at your mutual fund portfolio to see how your money is growing, it's best to use both indicators.
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