CAGR vs Absolute Returns: Which is Better for Mutual Funds?

The most important rule of investing is to carefully research and analyse your investment vehicles before actually investing. There are numerous strategies investors use to find the perfect mutual fund to invest in. Regardless of what strategy you choose, you will come across two metrics that are used to describe the performance of mutual funds: CAGR and Absolute Returns. 

In this article, we explore both CAGR and absolute returns to understand which is a better metric for finding the right mutual fund. 

What is CAGR?

The Compound Annual Growth Rate (CAGR) is a metric that indicates mutual fund investment returns generated over a specific time, assuming that your earnings are reinvested. It denotes the average annual growth rate of investment and measures how much your investment has grown over a particular period. It is a valuable tool for understanding long-term performance and comparing various investment options. 

CAGR may be calculated using the following formula: CAGR= (final value/initial value) ^ (1/n)-1

Suppose you invest Rs. 50,000 in a mutual fund. After 3 years, your investment grows to Rs. 70,000. Let's calculate the CAGR for this investment.

CAGR = (70,000 / 50,000)^(1 / 3) - 1

Your CAGR here is 11.86. This means your investment in the mutual fund grew at an average annual rate of approximately 11.86% over the 3-year period. 

What are Absolute Returns?

Absolute Returns refer to the total profit or loss made by your investment over a specific period, measured as a percentage. Absolute returns focus mainly on the initial performance and final performance of your investment, ignoring the time factor. The following formula can be used to determine absolute returns:

[(Current Value / Initial Investment Value) - 1] X 100 is the absolute return.

Assume that after investing Rs. 1,00,000 in a mutual fund, its value increased to Rs. 1,30,000 after eight months. To determine the return in absolute terms:

[(1,00,000 1,30,000) – 1] X 100 is the absolute return.

CAGR indicates that your investment increased by 30% during the eight months.

 What Are the Key Differences Between CAGR and Absolute Returns?

1. Time period

CAGR measures the average annual performance of mutual funds over a specific period, but absolute returns calculate the growth rate of your investment over a specific period. 

2. Suitability

Absolute returns gives you a quick snapshot of how an investment has grown over a period. It is suitable for understanding the growth in the short term. CAGR provides the annualised growth rate of an investment. It can be a better metric to understand long-term investments or to compare different investment tools.  

3. Accuracy

Absolute returns are the least accurate when comparing investments, but CGAR compares two different investments accurately.

Which is Better for Mutual Funds?

CAGR and absolute returns are two sides of the same coin, however how and when you use these may vary. CAGR is ideal for long-term investments as it measures the annual growth over a given period and provides a clear view of how your investments perform over the years. On the other hand, absolute returns give you a clear view of the profit or loss of your investments in the short-term. 

Final Insights

By understanding CAGR and absolute returns, you can make informed decisions that align with your financial goals. Beyond metrics and analysis, it is important to make your investment through reliable platforms. 

Tata Capital Moneyfy is a trustworthy platform that allows you to invest in various investment vehicles, compare your fund returns and performance, and analyse your investments, all in one place. To learn more about Tata Capital Moneyfy, click the Moneyfy website or download the app today!