While investing in mutual funds, the most frequent question traders ask is “How much has my investment actually grown to?” or “How much can I really expect it to grow to?”. Yes, absolute profits may give you a meaningful direction, but they often fail to capture the entire scenario. That’s where Compound Annual Growth Rate or CAGR comes into the picture.
CAGR shows how your investment really grew each year over a set time, if we consider the growth was smooth and consistent. It is one of the most frequently used indicators in the mutual fund industry for performance evaluation.
This guide will thoroughly explain what is CAGR in mutual funds, why it matters, how to figure it out, where it falls short, and how it compares with other return measures like absolute returns, annualised returns, and XIRR.
What is CAGR in a Mutual Fund?
Compound Annual Growth Rate or CAGR works as a financial component telling you the average yearly yield on an investment over a certain time. In contrast with return calculations, CAGR assumes that profits are reinvested yearly, making it suitable for sustainable mutual fund investments.
Imagine you put ₹1,00,000 in a mutual fund and after 5 years, its worth is ₹2,00,000. The CAGR specifies the usual yearly yield you gained to profit up to ₹2,00,000 that would have turned ₹2,00,000 from ₹1,00,000 in 5 years.
In brief, CAGR smooths out all the market movements to give you a uniform growth rate.
CAGR Full Form
CAGR indicates Compound Annual Growth Rate, where:
- Compound specifies that your returns are put into, profiting returns on returns.
- Annual specifies the growth rate is calculated on a per-year basis.
- Growth Rate is the pace at which your investment increases over a given period of time.
Thus, CAGR indicates the compound yearly growth rate of what you traded.
Why is CAGR Important in Mutual Funds?
In mutual fund investments, CAGR is vital for many reasons:
1. Shows Sustainable Performance: Mutual funds are better suited for long-term investments, and CAGR helps reflect this by smoothing out short-term fluctuations to show the fund’s overall growth over time.
2. Helps Comparison: You can see which fund performed better by comparing the CAGR of different funds across categories such as hybrid, equity, debt, or ELSS.
3. Offers Realistic Ideas: Instead of fixating on short-term gains, CAGR gives you an idea of steady growth.
4. Removes Confusions: Market movements can trick investors, but CAGR averages out returns into a single steady figure.
How to Calculate CAGR in Mutual Funds
To figure out CAGR, use this formula:
CAGR = (final value / primary value) ^ (1/n) – 1
Where:
- Final value is the traded amount at the termination point
- The initial value is the traded amount at the start
- n is the timeframe
Step-by-Step Example of CAGR Calculation
Assume, back in 2018, you traded ₹1,00,000 into a stock, which by 2023 had turned ₹2,50,000.
Step 1: Recognize Values.
- Primary value = ₹1,00,000
- Final value is ₹2,50,000
- n is 5 years
Step 2: Use the method
CAGR = (2,50,000 ÷ 1,00,000)^(1/5) – 1
Step 3: Shorten
CAGR equals to (2.5)0.2−1CAGR = (2.5)^{0.2} – 1
Step 4: Evaluate
CAGR=1.2009−1=0.2009CAGR = 1.2009 – 1 = 0.2009
CAGR = 20.09%
This indicates that the fund gave an average profit of around 20% yearly for five years.
CAGR vs Absolute Returns vs Annualised Returns
| Basis of Comparison | CAGR | Absolute returns | Annualised returns |
| Definition | Average compound growth yearly | Total growth percentage over the entire duration | Converts absolute return into annual growth rate |
| Considers Compounding | Yes | No | Yes |
| Best for | Sustainable trading | Temporary trading | Profits under 1 year |
| Instance | ₹1,00,000 → ₹2,00,000 in 5 years equals to CAGR of 14.8% | Similar investment equals 100% absolute return | Shows annual equivalent if held for 6 months |
CAGR is considered superior for sustainable fund performance.
CAGR vs XIRR in Mutual Fund Performance
CAGR is considered ideal for lump sum trading, but falls short with Systematic Investment Plans or SIPs.
That’s where the Extended Internal Rate of Return or XIRR has been proven to be advantageous.
- CAGR reckons a particular investment with a particular redemption.
- XIRR handles numerous inflows and outflows, which makes it more accurate for SIPs.
Let’s say, if you traded monthly ₹5,000 for 5 years, CAGR may miscalculate this, but XIRR delivers the exact profit percentage.
Tools to Calculate CAGR (Excel, Online Calculators, Apps)
1. Accurate Formula – Use
= ((Ultimate Value/Primary Value) (1/n)) −1= ((Ultimate\: Value / Primary\: Value) ^ (1/n)) – 1
Instance: = ((250000/100000) ^ (1/5))-1 = 20.09%
2. Digital CAGR Calculators: Numerous trading platforms offer free CAGR calculators online where you just input the initial and final value, along with the duration.
3. Mobile Applications: Many fintech applications like Zerodha, Groww, and ET Money offer CAGR and XIRR insights with graphics and comparisons.
Limitations of CAGR (What It Doesn’t Show)
Despite being powerful, CAGR has some limitations:
1. Overlooks Volatility: CAGR predicts seamless growth, but markets are not always stable.
2. Only initial and final points: It doesn’t record the happenings in between, so your portfolio could have fallen 30% one year and redeemed later.
3. Imperfect for SIPs: XIRR is more perfect for staggered investments.
4. Can mislead: A high CAGR over a short period may not persist for a long time.
CAGR in Different Types of Mutual Funds
- Equity Funds: Despite volatility, CAGR shows sustainable wealth creation potential.
- Debt Funds: CAGR helps differentiate debt funds, where profits are normally stable.
- SIP Investments: XIRR is recommended, but CAGR delivers a broader insight.
- ELSS Funds: CAGR helps assess post-lock-in growth, as ELSS brings a 3-year lock-in.
For instance, two ELSS funds may both give 50% total growth in 3 years, but one with a 14% CAGR and another with a 17% shows the second one delivered better performance.
How to Use CAGR for Mutual Fund Comparison
Traders should not depend on CAGR only, but use it as an initial benchmark while comparing funds.
1. Compare Alike Funds: You must not equate an equity large-cap fund’s CAGR with a debt fund.
2. Check Yields for 3-year and 5-year: Broader timeframes typically offer a comprehensive picture of the happenings.
3. Emphasis on risk-adjusted yields: Pool CAGR with components like Sharpe Ratio and Standard Deviation.
4. Never overlook fund stability: A one-time spike can result in improved CAGR, but you must check rolling returns to confirm consistency.
Conclusion
Whenever you have a question in mind about what is CAGR in mutual funds, you must know that it is one of the most dependable ways to evaluate mutual fund performance, particularly for lump sum investments held over many years. Eliminating temporary market clutter, it offers a transparent, compounded yearly growth rate.
However, you must remember that CAGR has limitations and doesn’t capture multiple investments or volatility. For SIPs, use XIRR. To help decide, always look at CAGR alongside other numbers.
If you want to find good mutual funds for sustainable trading, one of the best ways to spot consistent performers is by validating their 3-year or 5-year CAGR.
In brief, a CAGR can clear all the doubts that lie in the question “if my investment grew steadily annually, at what annual rate would it reach today’s value?”
FAQs
Compound Annual Growth Rate or CAGR assumes you reinvest any yields and determines the average annual growth of the amount you invested in a mutual fund. It offers a seamless growth rate over a duration, removing swings. Imagine you put ₹1,00,000 in a mutual fund and after 3 years it turns into ₹1,50,000, specifying the CAGR is about 14.47%. This indicates that every year your investment effectively grew 14.47%, even if actual annual returns varied between.
CAGR is calculated using the formula:
CAGR = (Ultimate Value / Primary Value) ^ (1/n) – 1
Here, the Ultimate value = final value of your investment, the Primary value = how much you put at the beginning, and n = duration. Assume you began with ₹50,000 and completed 4 years, it became ₹80,000, the CAGR would be (80,000 ÷ 50,000) ^ (1/4) – 1, which equals 12.7%. It offers a practical average annual growth rate.
A “good” CAGR is all about market movements and the type of mutual funds. Usually, if equity mutual funds give you about 12-15% each year over a long time, that’s pretty good. For debt funds, getting 6-9% yearly is okay because they’re safer investments. SIPs in equity, if held for 7-10 years, can generate double-digit CAGR. Lastly, a good CAGR should account for inflation and fit into your financial objectives with risk management.
Absolute return processes the entire percentage increase in trading, regardless of the time taken. CAGR, though, smooths out that growth gradually, giving you the average annual growth rate. Assume, in 3 years, ₹1,00,000 becomes ₹1,50,000, indicating the absolute return as 50%, but the CAGR will be 14.47%, indicating yearly growth. So, while absolute return is excellent for temporary investments, CAGR gives a better sense of sustainable mutual fund functionality.
CAGR is beneficial for one-time, lump-sum investments because it looks at just the start and end value eventually. XIRR, or Extended Internal Rate of Return, is ideal for SIPs or investments made at different times, as it takes care of multiple cash inflows and outflows. Assume if you trade monthly in a SIP, CAGR won’t show the actual scenario, but XIRR will. Hence, CAGR is simpler, but XIRR provides a more accurate performance measure for mutual funds with periodic investments.
