A good understanding of financial metrics is important for investors as it helps them monitor and rebalance their portfolios. Compound Annual Growth Rate (CAGR) is one such metric which is used to evaluate the annual growth potential of investments.
CAGR depicts how an investment’s value can grow on average annually across a specific tenure. It takes into consideration the compounding effect of investment and provides an accurate picture of its performance when compared to the average growth rate.
Calculating CAGR has become easy with online CAGR calculators. In this article, we will focus on the important details of this online tool.
A CAGR calculator is an online financial tool which helps to calculate the compound annual growth rate of an investment over a selected timeframe. Users need to only enter the initial investment, final value and duration of investment to view the CAGR in the calculator.
This financial tool can be used to compare Returns on Investment (RoI) against a particular benchmark or other similar investments. You can use this tool to make financial plans and compare stocks and mutual funds.
Follow these steps to use the Samco CAGR calculator:
Step 1: Enter the details of your initial investment.
Step 2: Enter the expected or final investment value and duration of investment. You can type in or drag the slider to enter these values.
The growth rate will be displayed on the screen. It is that easy!
Check the benefits of using our online CAGR calculator:
1. Helps to Compare Various Investment Products
You need to input the values of the initial and final investment into the CAGR calculator to understand the growth of your investments. So, you can compare the performance of various investment options using the calculator. This helps you understand which investment is most likely to generate high returns in the future.
2. Lets You Set Realistic Financial Goals
You can use a CAGR returns calculator to set financial goals depending on the rate of return you desire. By entering different values into the calculator, you can determine the growth required to fulfil your financial objectives.
3. Takes into Account Investment Tenure
Another important benefit of a CAGR calculator is that it takes into account the tenure of an investment, so it can serve as a nearly-accurate indicator of growth over time. So, if you have made any investments, you can check the CAGR calculator to see how much they have grown annually.
4. Helps to Evaluate Risk and Volatility
You can check the risk and volatility associated with investments with the help of a CAGR calculator. An analysis of CAGR over different periods will help you to make better investment decisions regarding asset allocation and risk management.
CAGR is an accurate way to determine the rise or fall in the value of one’s investment portfolio over time. While many investors tend to consider the absolute returns generated by an investment, it can be a bit misleading. This is because absolute returns don't show how much an investment has grown each year.
Realistically, many investments do not keep growing at the same rate every year. In some years, the growth rate can be high while in other years, it can be low or even negative. This is exactly when CAGR should be used.
CAGR shows the average returns that an investment has earned every year for a timeframe. It is a representational figure which helps to fix the limitations of absolute returns. You can use CAGR to compare the historical returns of multiple types of investments, including stocks, mutual funds or even savings accounts.
Before the advent of online financial tools like the CAGR calculator, people undertook manual calculations. Here is the mathematical formula to calculate the CAGR:
CAGR = (FV/PV)^(1/n) – 1
FV = Future value of an investment
PV = Present value
N = Investment tenure (in years)
Let’s understand this with an example. Suppose Tarun had made an initial investment of ₹2,00,000 in a business. It is the present value (PV). Suppose the total investment value has increased to a value ₹5,00,000 after a tenure of 5 years. Then, the CAGR would be as follows:
(5,00,000/2,00,000)^1/5 – 1 = 20.11
So, the CAGR percentage is (CAGR x100) or 20.11%.
There is no definite answer to this question. A good CAGR percentage depends on the risk and volatility of an investment option and can range from 8% to 20% or even 30%. It mainly depends on the type of investment.
For instance, a CAGR of 8-10% is considered adequate for large-cap stocks as well-established companies do not have much room to grow exponentially. In contrast, a CAGR of above 15% is good for small-cap companies as they have much higher growth potential.
For an investor’s portfolio, a CAGR of around 25% can be considered excellent. However, it is important to note that one has to bear high risks to get such returns.
A negative CAGR stands for a decline in a business or an investment’s value over a specific timeframe. So, if you find that the CAGR of your investment is negative, it means that your investment has garnered a negative average annual growth rate.
There are several reasons why an investment can experience negative growth:
If your portfolio has a negative CAGR, you need to evaluate the reasons behind the decline and come up with strategies for improvement. These may include restructuring the investment portfolio, formulating new strategies and seeking professional advice for changing the situation for the better.
Calculating the growth rate of an investment helps people to make better financial plans. But the growth rate is different from CAGR. It is defined as a linear measure that does not take into account compound growth.
Here is a table showing the differences between these two financial metrics:
|Time period||CAGR is calculated for a specific timeframe.||People can calculate the growth rate for any tenure.|
|Calculation||CAGR indicates the average annualised growth rate of an investment.||Growth rate considers the rate of change between two values.|
|Compounding effect||CAGR takes into account the compounding effect.||The growth rate does not account for compounding.|
|Impact of fluctuations||It’s not sensitive to market fluctuations when it comes to individual years.||The growth rate is sensitive to fluctuations during individual years.|
|Suitable for||CAGR is more suitable for conducting long-term analysis of an investment.||The growth rate is suitable for analysis of various things from investments to GDP and turnover.|
|What does it show?||CAGR indicates the average growth rate over time.||The growth rate shows the specific growth rates at each interval.|
|Smoothening||CAGR smoothens the effect of volatilities that take place in a year.||The growth rate accounts for volatile changes that take place every year.|
You can use both absolute returns and CAGR to estimate returns generated from an investment. But, there are differences between these two financial metrics:
|Points of Difference||Absolute Returns||CAGR|
|Time period||This metric takes into account the change in value between two specific points in time.||CAGR takes into account the entire timeframe which is to be evaluated.|
|Calculation||You have to subtract the initial value from the final value to calculate absolute returns.||CAGR is calculated as the average annual growth rate over a particular tenure.|
|What does it show?||It shows the actual change in value without taking into consideration the time factor.||It evaluates growth after smoothening out year-to-year volatility.|
|Compounding||It does not take into consideration the effect of compounding.||This metric takes into account the effect of compounding, via reinvestment of profits.|
|How is it useful?||Absolute returns help to assess the gains/losses of short-term investments.||CAGR helps to evaluate the performance and growth potential of long-term investments.|
|Volatility||It does not take into account volatility and shows absolute change irrespective of fluctuations.||CAGR smoothens out year-to-year fluctuations and offers a stable growth rate.|
You can use a risk-adjusted CAGR to evaluate the risk level of an investment. It takes into account an investment’s volatility, variability, downside potential and returns. In simple words, a risk-adjusted CAGR helps you to assess the potential returns on investment while taking into consideration the level of risk involved.
Risk-adjusted CAGR is useful while comparing investment options with varying risk profiles. You must remember that an investment with a high-risk level may generate higher returns, but can also lead to substantial losses. On the other hand, investment options with lower risk levels may avoid losses but tend to yield lower returns.
Compound Annual Growth Rate (CAGR) remains one of the most useful financial metric for measuring the performance of stocks and mutual funds. If you want to keep constant track of your investments, download the Samco app today!
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A clear understanding of CAGR will help you to make better investment-related decisions. The financial metric indicates how an investment performs annually across a timeframe. An online CAGR calculator provides accurate results instantly unlike the time-consuming process of manual calculations.
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