As an investor, it is critical to assess the performance of your mutual fund investments. One of the best ways to track and compare mutual fund returns over time is using the CAGR (Compound Annual Growth Rate). A CAGR calculator is an easy-to-use and effective tool that helps determine the annual growth rate of your mutual fund investment while accounting for the effect of compounding. Continue reading to understand how to use a CAGR calculator.
What is CAGR?
CAGR stands for Compound Annual Growth Rate. It indicates an investment’s average annual growth rate over a specified period, assuming profits are reinvested each year.
CAGR smooths out return volatility and gives a more accurate picture of investment performance, as it takes into account the compounding effect. The CAGR metric allows for standardised comparisons of different investments over varying periods.
Why Track CAGR for Mutual Funds?
Here are some key reasons why CAGR is a critical metric to track for mutual fund investments:
- Assess actual returns: CAGR helps determine the accurate return generated on your mutual fund investment annually after accounting for the impact of compounding.
- Compare fund performance: CAGR allows you to compare returns across mutual funds over the same period.
- Gauge against benchmarks: To evaluate performance, you can assess a fund’s CAGR against market indexes.
- Set realistic expectations: Analysing historical CAGR gives a realistic idea of expected future returns.
- Identify best and worst periods: CAGR over different time segments can identify a fund’s best and worst periods.
- Make informed decisions: CAGR figures help make prudent decisions on investing, withdrawing or switching investments.
How to Calculate CAGR
The formula to manually calculate CAGR is:
CAGR = (End Value/Start Value)^(1/No. of Years) – 1
Where:
- End Value = Mutual fund value at the end of the period
- Start Value = Mutual fund value at the beginning of the period
- of Years = Total no. of years between the start and end period
Using an Online CAGR Calculator
While you can calculate CAGR manually, using an online CAGR calculator is more convenient. Here are the steps to use a CAGR calculator:
- Input start and end values: Enter the mutual fund value at the beginning and end of the investment period.
- Specify period: Enter the total no. of years over which the investment was held.
- Generate CAGR: The calculator will process the inputs and display the CAGR percentage.
- Review results: Check the calculated CAGR figure and the chart showing growth over time.
Online calculators also let you customise parameters and provide helpful data visualisations, enabling quick and easy CAGR calculations.
Advantages of Tracking CAGR
The following are the advantages of tracking CAGR:
- It requires only a start value, end value, and time period to calculate, making it simple to determine, unlike other complex return metrics.
- It helps you accurately evaluate your mutual fund investments’ actual annualised growth rate after accounting for the impact of compounding over time.
- Simplifies performance comparison across mutual funds you have invested in over varying multi-year periods.
- Eliminates the distorting impact of short-term market volatility and abnormal gains or losses on specific funds.
- Analysing historical CAGR trends allows you to set realistic expectations for future returns that align with long-term performance.
- It enables you to clearly identify the best and worst-performing mutual fund managers and schemes based on their CAGR track records over different time segments.
- It helps optimise your overall mutual fund portfolio by directing more investments into funds with higher CAGR and weeding out poorer performers.
- It guides more prudent mutual fund investment decisions that are aligned with your expected return requirements and long-term financial goals.
Limitations of CAGR
While CAGR is a robust metric, it also has some limitations:
- Assumes a constant growth rate rather than reflecting the volatility in periodic returns over the investment tenure. Actual mutual fund returns fluctuate based on market movements.
- Does not account for the impact of any additional inflows into the fund or outflows from redemptions during the investment period under consideration.
- Prone get skewed if used over very short time frames or in cases where start or end values are extreme outliers.
- It does not consider the impact of underlying risk factors, such as expense ratio and exit loads, and taxes on capital gains impacting the investor’s net profits from the mutual fund investment.
- The past CAGR performance of a mutual fund may not accurately indicate or guarantee its expected future growth rates. External factors can lead to divergence.
Using CAGR to Track and Compare Mutual Funds
Keeping the advantages and limitations in mind, CAGR can be effectively used to track and compare mutual fund performance:
- Evaluate a mutual fund’s CAGR performance over periods of three years, five years and ten years to identify short-term and long-term performance trends.
- Compare CAGR across different schemes of the same mutual fund, including direct plans, regular plans, dividend reinvestment plans and growth plans over the same timeframe.
- Gauge a mutual fund’s CAGR against the category average CAGR of its peers to assess how it has performed compared to the competition – be it equity, debt, hybrid, solution-oriented or index funds.
- Assess a fund’s CAGR against key benchmark indices over a timeframe to evaluate its performance versus the broader market, such as the Sensex, Nifty 50, BSE 200, BSE 500, etc.
- To determine whether your investments are on track, compare the mutual fund CAGR against the expected CAGR returns required to achieve your specific financial goals.
- To allow for reasonable comparison and performance assessment, focus more on long-term CAGR spanning minimum 5-10 year periods rather than short-term CAGR.
Conclusion
CAGR is a simple yet powerful metric that helps mutual fund investors accurately assess portfolio performance, identify top-performing funds, and make prudent investment choices. Leverage online CAGR calculators to track CAGR across all your mutual fund investments effortlessly. However, be aware of the limitations of CAGR analysis. Use CAGR figures combined with associated risk factors to make informed mutual fund investment decisions to achieve your long-term financial objectives. For easy access to a CAGR calculator and expert mutual fund investment advice, visit Motilal Oswal Financial Services.
