Investors evaluate the performance of mutual funds and other investments using different metrics. Two of the most commonly used ones are Compound Annual Growth Rate (CAGR) and Absolute Returns.
Understanding the difference between these two methods can help you make informed decisions about your investment in UAE. This article provides a comprehensive comparison of CAGR vs Absolute Returns, explaining their calculations, differences, and suitability for various investment scenarios.
Compound Annual Growth Rate (CAGR) measures the annualised return of an investment over a specific period, assuming that profits are reinvested. It helps you understand how an investment grows each year at a steady rate, smoothing out fluctuations.
CAGR Formula:
CAGR= { [(End value/ Beginning value) ^ 1/n] - 1 } x 100
Where:
Example:
If you invested AED 8,000 and its value increased to AED 12,000 over 3 years, the CAGR would be —
CAGR = [((12,000/8,000)^1/3)) - 1 ] × 100 = 14.47%
CAGR provides a clearer picture of investment growth over time and is ideal for comparing different investment options
Absolute Returns measure the total percentage increase or decrease in investment value without considering the time period. It is a straightforward calculation showing how much the investment has grown.
Absolute Return= [(Final Value - Initial Investment)/Initial Investment)] × 100
If you invested AED 5,000 in a mutual fund in UAE and its value grew to AED 8,500, the absolute return would be —
Absolute Return = [(8,500 −5,000)/5,000)] × 100 = 70%
Absolute returns are useful for short-term investments. However, they don’t provide insights into annualised growth.
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Here’s a detailed comparison to help you choose between CAGR vs Absolute Returns —
Parameters | CAGR | Absolute Returns |
---|---|---|
Definition | Annualised return over a specific period | Total return on investment |
Formula | [(EndingValue/BeginningValue)^(1/n) − 1] × 100 | [(Current Value - Initial Value) / Initial Value] × 100 |
Time Consideration | Takes investment duration into account | Ignores time period |
Accuracy | More accurate for comparing investments over different timeframes | Less accurate for long-term investments |
Best for | Long-term investments (more than a year) | Short-term investments (less than a year) |
Both CAGR and absolute returns have their own advantages —
Mr. Kalim invested AED 50,000 in 2010. This amount grew to AED 80,000 by 2020.
The absolute return looks impressive, but CAGR reveals that the investment grew only 4.81% per year. Thus, the latter provides a more realistic growth picture.
Read More: XIRR Meaning in Mutual Funds
Understanding the difference between CAGR and Absolute Returns is essential for evaluating investment performance effectively. While absolute returns show the total increase in investment, CAGR provides a clearer picture of annual growth, making it ideal for long-term planning.
By using both metrics appropriately, you can make better financial decisions and optimise your portfolios.
CAGR considers the investment duration, making it useful for comparing different investments. Absolute returns only show total growth and don’t reflect yearly performance.
Yes, CAGR is negative if the investment's final value is lower than its initial value, indicating a decline over time.
No, because it doesn’t account for time. An investment with a high absolute return over many years may have a lower annual growth rate than one with a lower absolute return over a short period.
No, CAGR is best for long-term investments. Short-term investors should rely more on absolute returns for quick performance analysis.
By using this formula CAGR= {[(End value/ Beginning value) ^1/n] - 1} x 100, you can convert total return into an annualised percentage and compare different investments more effectively.