What you should know about Compound Annual Growth Rate (CAGR)
We invest in order to create wealth. To achieve this, it important to let your investments ‘compound’. This is where the concept of Compounded Annual Growth Rate (CAGR) comes in the picture.
Some say absolute returns is the right way to calculate returns. However, absolute returns take the initial investment amount and the maturity amount when calculating returns, whereas CAGR gives an idea on how much you wealth has grown over a specific period. The CAGR method measures the percentage of the increase or decrease of an investment year-on-year. It takes in account the tenure of an investment period giving you a more accurate and comparable earnings percentage.
CAGR follows a formula to compute returns:
CAGR (%) = Absolute Returns/Investment Tenure (years).
When investing, it is important to consider the CAGR over absolute returns as it’s not just about higher returns but also about faster and greater returns. The quicker your principle grows the more you would allow your investments to grab the compounding benefit. CAGR allows you to evaluate your options more efficiently and when investing in mutual funds, the best way to calculate more efficiently would be CAGR.CAGR helps you or the fund managers compare investments based on their returns in the most accurate way despite the rise and fall in value over time. When investing, you can also compare the CAGR of two alternatives if you need to evaluate the performance of a stock to its peers or the market index. CAGR does not reflect investment risk, though during market volatility, the investment may appear erratic and uneven.