Investing in mutual funds is a smart way to diversify risk while growing your wealth. A mutual fund uses your money and invests in various asset categories like debts, bonds, and equity, ensuring a well-balanced portfolio. In addition, a mutual fund also has different types of funds available for each type of investor.
One key metric investors often come across while evaluating mutual funds is CAGR (Compound Annual Growth Rate). Understanding CAGR helps you analyse a fund’s historical performance and make informed investment decisions.
This blog also guides you on the CAGR meaning, explains how it is calculated, and guides you on finding mutual funds with strong CAGR performance.
Understanding the Compound Annual Growth Rate (CAGR)
The full form of CAGR is the Compound Annual Growth Rate, which is a metric to measure the growth of a particular mutual fund in a specific period. A CAGR in mutual funds denotes the yearly growth rate of the value of investments. It helps to address fluctuations and ensure a clear overview of its performance.
Let us take an example to understand the compound annual growth rate meaning. You have invested ₹5,000 in a mutual fund, which would grow at a CAGR of 10% in the next five years. This means that your investment will increase by an average of 10% every year. However, the actual growth in each year can be different since it offers market-linked returns.
It could be 9% in the first year, 11% in the second year, 12% in the third year, and so on. You will get a consistent growth rate by analysing CAGR which can be used for comparing mutual funds.
What is the Formula of CAGR?
Since you have understood what is CAGR, getting informed about the formula of CAGR is crucial for you. You can use the below formula to calculate the CAGR of your mutual fund:
CAGR = (Final Investment Value/Initial Investment Value)(1/n)-1
Here, the final value is the value of investments at the end of your investment period. Whereas, the initial value is the value when you have started investing in the mutual fund. Additionally, ‘n’ is considered as the number of years that you have invested in the mutual fund.
Calculation of Compound Annual Growth Rate
The calculation of the compound annual growth rate is the most interesting part of the overall concept. It is very easy to calculate the CAGR of a mutual fund. The below calculation is an example of how you can get a CAGR of a particular mutual fund.
You have invested in the ABC mutual fund for a period of five years (n) with an initial investment of ₹1,00,000. After five years, you have seen that the value has reached ₹1,80,000. Using the above formula, the CAGR of ABC mutual fund will be:
(1,80,000/1,00,000)(⅕)-1 = 12.47% per annum
The CAGR of this ABC mutual fund is 12.47% per annum, which means this mutual fund has grown 12.47% annually over the last five years.
Uses of CAGR in Mutual Funds
The CAGR in a mutual fund attracts investors and is useful in mutual funds for multiple purposes:
- A CAGR helps to measure and compare the investment performances of a mutual fund in a specific period. This helps investors to analyse those investments in the fund, focusing on the average growth rate in a year instead of absolute numbers.
- With the help of CAGR, an investor can make a long-term plan for their investment. As an investor, you can easily estimate the growth of a particular mutual fund over time. Investors can predict the future value of their investment and make the right decisions with the help of the compound annual growth rate.
- Investors can evaluate a mutual fund’s historical performance before making any investment with the help of a CAGR. They can make appropriate investment strategies and evaluate the risks, by comparing among different mutual funds.
- CAGR allows individuals to assess any risk associated with a mutual fund scheme. A mutual fund can be considered stable and reliable if its CAGR is consistent over a longer period.
Benefits of CAGR
A compound annual growth rate helps an investor in numerous ways while investing in a mutual fund. Here are some of the benefits that you can get from a CAGR:
- You can measure the growth of different mutual funds while making comparisons between them at different durations.
- A CAGR allows you to analyse the effect of short-term market fluctuations on a mutual fund.
- A CAGR can assist you in evaluating the long-term performance of a particular mutual fund. This helps you to make a strategic decision before investing in a fund.
- You may avail the benefit of the power of compounding from CAGR. For instance, if you invest ₹100 in a mutual fund and earn a CAGR of 10%, you will receive ₹110 in the first year. In the second year, your total returns will be ₹121 (10% of ₹110+110).
Drawbacks of CAGR
Even though there are a lot of benefits of a CAGR, there are some drawbacks too. Below are some of the drawbacks included in a CAGR:
- Despite the accuracy, a CAGR depends on historical data rather than predicting future returns correctly. There can be some future risks and you can face high fluctuations in price.
- CAGR should not be fully trusted for high-value investments or inconsistent growth patterns.
- CAGR disregards the variations in market timings and conditions and assumes a growth rate consistently.
How to Find Mutual Funds With High CAGR?
Here are some tips you can follow to find mutual funds with high CAGR:
- First of all, you must do efficient research on mutual funds that are in line with your investment objectives.
- Examine the historical Compound Annual Growth Rate (CAGR) to understand how the investment has performed in various situations. You can analyse this information through fund fact sheets and websites. Focus on shortlisting mutual funds that have consistently high CAGR over an extended period.
- You should prioritise funds that have a strong CAGR historically if your investment goal is for long-term purposes such as retirement. This will allow you to get sustained growth from a mutual fund.
- Focus on diversifying rather than putting all your money in a single mutual fund, even if it comes with high compound annual growth returns. You can spread the risks and lessen the fluctuations in your investment portfolio if you diversify your investments in different asset classes.
- You can find detailed CAGR data, information and tips on selecting high-performing mutual funds by visiting the Torus Digital website. It offers valuable insights into which mutual funds have lower expense ratios and the expertise of fund managers.
Final Thoughts
Understanding what is CAGR in mutual funds is crucial for investors who are looking to invest in mutual funds. The CAGR in mutual funds assists them in analysing the yearly growth rate of a mutual fund. Investors can compare and contrast different mutual funds with the help of a CAGR. Addressing market fluctuations is another benefit of this indicator which makes investors start their wealthy journey.
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