Everything You Should Know About CAGR

This metric helps investors understand how much an investment has grown annually over a specific period, assuming a steady growth rate. Unlike absolute returns, CAGR smooths out fluctuations, making it a useful tool for comparing different investments.

What is CAGR in Mutual Funds?

CAGR (Compound Annual Growth Rate) represents the average annual growth rate of an investment over a set period. It assumes that the investment grows at a steady rate each year, even though actual returns may vary. This metric is commonly used in stock markets, mutual funds, and business financial analysis to evaluate performance over time.

Formula: CAGR = {(EV/BV)^1/n} − 1) × 100

Where

• EV = Ending Value of the investment
• BV = Beginning Value of the investment
• N = Number of years

Example

Suppose you invested AED 10,000 in a stock, and its value grew to AED 20,000 in 5 years. The CAGR would be calculated as —

CAGR = {[(20,000 / 10,000) ^ (1/5)] - 1} x 100 = [(2 ^ 0.2) - 1] x 100 = 14.87%

This means your investment grew at an average annual rate of 14.87% over 5 years.

Why is CAGR Important?

CAGR is widely used because it provides a realistic measure of investment growth. Some key benefits include —

• Clarity: Gives a single annualised rate of return, making comparisons easier
• Comparative Analysis: Helps you compare different investments, funds, or stocks
• Performance Benchmarking: Assists in evaluating business growth, stock performance, and market trends

Features to Consider When Using CAGR

Here are some key factors to consider when using CAGR to analyse investments —

• Market Fluctuations: Markets go up and down, which can impact CAGR. High short-term returns or losses don’t always last, so it’s important to consider long-term trends and volatility.
• Currency Changes: If investing in foreign markets, currency exchange rates can affect CAGR. Consider these fluctuations when evaluating returns.
• Risk: CAGR doesn’t show the risk involved in an investment. A higher CAGR may mean better returns, but it could also come with high risk. Always check the risk level before making decisions.
• Time Period: The longer the time frame, the more accurate the CAGR. Short-term calculations can be misleading, so use consistent time periods when comparing investments.
• Fees: Any applicable fees can reduce your actual returns. Always factor this in when calculating CAGR.

*Currency exchange rates are subject to change

How to Use CAGR?

CAGR is useful in various financial scenarios, including —

• Investment Analysis: Evaluating stocks, mutual funds, and fixed-income securities
• Business Growth Measurement: Assessing revenue, sales, or market capitalisation trends
• Comparing Alternative Investments: Understanding how different investment options perform over time

CAGR in Mutual Funds and Stocks

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Frequently Asked Questions