What Is CAGR in Mutual Funds?
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- Updated 16 Sep 2025
Mutual funds are popular investment vehicles among a range of investors. When assessing a mutual fund's performance, one crucial metric that investors often look at is the compounded annual growth rate (CAGR). CAGR is an essential tool that helps investors gauge the fund's historical returns and make more informed investment decisions.
Meaning of CAGR
CAGR is a measure used to determine the annualised growth rate of an investment over a specific period, taking into account the effects of compounding. Unlike the simple average, which calculates the arithmetic mean of returns, CAGR considers the compounding effect, providing a more accurate representation of an investment's true growth rate.
How to Calculate CAGR in Mutual Funds?
Now that you know CAGR's full form and meaning let's see its computation methodology. To calculate the CAGR for a mutual fund, the initial investment value (usually denoted as "Beginning Value") and the final investment value (usually denoted as "Ending Value") are required. The formula to calculate CAGR is as follows:
CAGR = (Ending Value / Beginning Value)^(1 / Number of years) - 1
For example, suppose an investor initially invested Rs 10,000 in a fund, and after five years, the investment grew to Rs 15,000. The CAGR for this investment would be:
CAGR = (15,000 / 10,000)^(1 / 5) - 1 ≈ 0.0834 or 8.34%.
Absolute Returns vs CAGR in Mutual Funds
Absolute returns measure the total growth of an investment over a period without considering time. The formula is: Absolute Return (%) = [(Final Value – Initial Value) ÷ Initial Value] × 100
CAGR shows the annualised growth rate of an investment, factoring in compounding across multiple years. The formula is: CAGR = (Ending Value / Beginning Value)^(1 / Number of years) -1
Example: If you invest Rs. 1,00,000 in a mutual fund and it grows to Rs. 1,50,000 in 3 years:
- Absolute return = (1,50,000 – 1,00,000) ÷ 1,00,000 × 100 = 50%
- CAGR = (1,50,000 ÷ 1,00,000)^(1/3) – 1 = 14.47% annually
Thus, absolute return shows total gain, while CAGR reflects yearly growth.
Interpreting CAGR Results
The CAGR percentage represents the annual growth rate of the investment over the specified period, assuming that the investment's growth was steady and compounded. A positive CAGR indicates that the mutual fund generated positive returns over the chosen time frame. Conversely, a negative CAGR suggests a loss in value.
Interpreting CAGR Results
The CAGR percentage represents the annual growth rate of the investment over the specified period, assuming that the investment's growth was steady and compounded. A positive CAGR indicates that the mutual fund generated positive returns over the chosen time frame. Conversely, a negative CAGR suggests a loss in value.
What Is a Good CAGR?
A good CAGR depends on the type of investment, risk level, and market conditions. For equity mutual funds, a CAGR of 10-12% over the long term is generally considered strong, as it outperforms inflation and fixed-income options. In contrast, debt funds or fixed deposits usually deliver a lower CAGR of 5-7%, but with lower risk. For aggressive investors, higher CAGR targets above 15% may seem attractive, but they often involve significant volatility and risk. Instead of chasing high numbers, focus on achieving a CAGR that is consistent, sustainable, and aligned with your financial goals. A “good” CAGR is one that balances returns with your risk appetite and helps you reach your long-term objectives.
Importance and Advantages of CAGR in Mutual Funds
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Long-term Performance Assessment: CAGR is an invaluable tool for evaluating the long-term performance of mutual funds. It provides investors with a better understanding of the fund's growth over time, helping them identify trends and patterns.
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Risk Assessment: CAGR also assists in assessing the risk associated with a mutual fund's investment strategy. If the fund exhibits a high CAGR, it might indicate higher volatility and risk in achieving such returns. On the other hand, a stable and consistent CAGR suggests a more conservative approach.
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Comparison of Investment Options: CAGR allows investors to compare the performance of various funds over the same period. It helps investors make informed decisions by analyzing which fund has historically provided better returns.
How to identify mutual funds with higher CAGR
To identify mutual funds with higher CAGR, you need to evaluate both historical performance and future growth potential. Start by reviewing a fund’s CAGR over different time horizons – 1 year, 3 years, 5 years, and 10 years. Consistency across longer periods is a strong indicator of stability rather than short-term spikes. Compare these returns with the benchmark index to see if the fund has consistently outperformed.
Next, assess the fund manager’s track record, investment strategy, and portfolio composition. Equity funds focusing on high-growth sectors or well-managed diversified funds often deliver better CAGR over time. Also, check expense ratios, as lower costs improve net returns.
Look into risk-adjusted returns using ratios like Sharpe or Sortino, since high CAGR without risk control may not be sustainable. Finally, avoid selecting funds solely on past returns; align your choice with your risk profile, investment horizon, and financial objectives.
CAGR Limitations
While CAGR is an essential metric, investors should be aware of its limitations:
- Past Performance: CAGR is calculated based on historical data, providing a retrospective view of how the mutual fund performed over a specific period. However, it is crucial to remember that the financial markets are dynamic and subject to constant change.
Economic conditions, geopolitical events, regulatory changes, and other external factors can significantly influence the performance of investments in the future. What performed well in the past may yield different results in the coming years.
- Smoothing Effect: CAGR assumes steady compounding over the investment period, which may not always be true. The actual returns fluctuate significantly from year to year due to various factors that impact the performance of mutual funds.
Mutual funds follow different investment strategies based on their objectives, such as growth, income, or a combination of both. Depending on the market environment and the fund manager's decisions, the investment strategy may shift or experience periods of higher risk-taking. This can lead to uneven returns over time, impacting the fund's CAGR.
CAGR vs XIRR
| Basis of Comparison | CAGR (Compounded Annual Growth Rate) | XIRR (Extended Internal Rate of Return) |
|---|---|---|
Definition | Annualised growth rate of an investment assuming compounding. | A method to calculate returns when investments and withdrawals are irregular. |
Use Case | Best for lump-sum investments held continuously for a fixed period. | Ideal for SIPs, SWPs, or investments with multiple cash flows at varying times. |
Assumptions | Assumes a single initial investment and one final redemption. | Considers each cash inflow and outflow along with dates. |
Accuracy | Simple but limited when cash flows are uneven. | More accurate for real-life scenarios involving multiple transactions. |
Investor Relevance | Shows overall growth rate over time. | Reflects actual investor experience of returns considering timing and amount of flows. |
Summing It Up
CAGR is a valuable tool for investors like you seeking to understand the historical performance of mutual funds. However, you should not rely solely on CAGR when making investment decisions. Considering other factors, such as the fund's investment objectives, risk profile, and market conditions is crucial. A comprehensive analysis, combined with CAGR, will enable you to make well-informed choices and build a robust investment portfolio.
FAQs
How does CAGR work in mutual funds?
CAGR is computed as per this formula (Ending Value / Beginning Value)^(1 / Number of years) - 1. So, suppose an initial investment of Rs. 1000 made five years ago has grown to Rs. 1800 today, although the absolute growth rate of the investment is 80%. In that case, the Compound Annual Growth Rate (CAGR) represents the average annual return on the investment earned over the entire period. In this case, the CAGR is calculated to be 12.5%.
What is the drawback of CAGR?
The primary drawback of the CAGR is its reliance on calculating a smoothed rate of growth over a specific period, which overlooks volatility and may inaccurately suggest a consistent and steady growth throughout that duration.
How many years do you need to calculate CAGR?
Investors commonly employ CAGR as a performance metric for investments, often focusing on a three-year or five-year period. Nevertheless, you can also utilize it to track an investment's performance over more extended time frames.
How accurate is the CAGR?
CAGR offers precise projections of the annualized growth rate for investments or specific metrics. For more reliable outcomes, it is advisable to use extended periods when calculating compound annual growth rates. However, despite using longer timeframes, it's important to note that CAGR cannot fully account for volatilities, regardless of how consistent growth has been in the past.
What is a good CAGR for mutual funds?
If you seek stable returns through investments in robust and established companies from the financial market, a CAGR percentage of 8% to 12% would be considered favourable for your investment objectives. On the other hand, for investors willing to take on moderate to high risk by investing in companies with growth potential, a CAGR percentage of 15% to 25% would be considered a more suitable target.
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