Entrepreneurs want growth in their businesses while investors want growth in their investments. However, whether the businesses or the investments are growing or not will become clear only after one has measured their growth. So, how is this growth measured in the case of businesses and investments?
The answer lies in the CAGR. What is it? Let’s find out!
What is CAGR?
CAGR, also known as compound annual growth rate, is a measuring tool for determining how much growth a company or investment has achieved. It shows growth as a percentage compounded yearly. As CAGR also considers the time value of money, the actual returns on investment generated over a year get reflected through CAGR. To calculate the CAGR, the following formula is used:
CAGR = [(Ending Value/Beginning Value) ^ (1/N)] – 1
Let’s understand this formula with a practical example:
Amount invested: Rs. 15,000
Investment value after 3 years: Rs. 30,000
Therefore, N = 3 years
CAGR = (30,000/15,000) ^ (1/3) – 1
If you want to find the absolute return on your investment, then you can use the following formula:
Absolute return = [(30,000 – 15,000) / 15,000] * 100
It is challenging to use the above formula for every calculation. This is particularly true when you are planning your finances and examining several asset classes with differing rates of return. For instance, if you have investments in five different asset classes and want to know how each one is performing, you may do so by calculating the compound annual growth rate of each asset class. However, applying the above method will lengthen the process. What then is the alternative?
The CAGR calculator is a utility tool that allows you to calculate the compounded annual growth rate based on your inputs. It helps a lot when it comes to financial planning and decision-making.
Following are the steps to use the CAGR calculator:
- Fill in the initial value of the investment. This is the amount that you have invested in any of your asset classes.
- Fill in the final value of the investment. The final value shall be as on the date for which you want to calculate your CAGR.
- Fill in ‘N’. ‘N’ represents the number of years for which you held your investment. For instance, if you invested on 1st January 2019 and redeemed your investments on 31st December 2021, then ‘N’ will be 2 years.
What are the benefits of the CAGR calculator?
The CAGR calculator online is one of the most used financial tools among investors. Following are the benefits of the CAGR calculator that makes it such a popular tool amongst investors:
- It is easy to use. With minimal input, you get your desired results.
- You can also use it as a mutual fund calculator. In case you have made lumpsum investments in any mutual fund, then you just need to enter the amount invested, its value on a particular date, and the number of years.
- It allows you to make comparisons easily with quick results. Just enter the inputs and you get your CAGR immediately. You can use the CAGR return calculator for calculating returns on your existing investments and restructure your portfolio such that to minimize the low-return yielding assets and increase the proportion of high-return yielding investments
- The CAGR calculator online is beneficial when it comes to future financial planning. You can set your investment goals and targets you want to achieve over a period of time and determine the class of asset accordingly. For instance, if you have Rs. 2,00,000 today and within 5 years, you will require Rs. 4,50,000, then you need to invest Rs. 2,00,000 such that it grows with a CAGR of 17.61%. Therefore, you just need to select an asset class that provides an annual return of 17%-18%. Investment decisions get a lot easier and more accurate with the CAGR calculator.
- The CAGR calculator can be used to compare the performance of any stock with its peers as well as to the performance of other industries.
What are the limitations of the CAGR calculator?
While the CAGR calculator is a handy tool, it certainly has its own limitations. The following are the limitations of the CAGR calculator:
- The CAGR calculator does not consider volatility. For instance, if you have derived a CGAR of 30% over a period of 5 years, then the CAGR calculator assumes that you have received a 30% growth rate for each of the 5 years. It does not consider the volatility i.e., for a particular year, the return may be 20% while for another year, the return may be 45%.
- The CAGR calculator can be used to derive returns only for lumpsum investments. When it comes to calculating returns on the Systematic Investment Plan (SIP), CAGR cannot calculate the same. The reason is that CAGR only considers the initial investment and final investment value whereas, in the case of SIP, the investments are done each month over a period of time. Therefore, to calculate the return on SIP, XIRR is being used.
- CAGR does not account for the risk involved to achieve such returns; it only displays the return on investment. Before making an investment, it’s important to understand the risk. For instance, risk-adjusted return is more significant than CAGR returns in the case of investments in equities, shares and instruments. Treynor’s ratio and Sharpe’s ratio must be used to evaluate investment risk.
In a nutshell
The CAGR return calculator has been the key decision driver for many investors. When it comes to investments where you have set financial goals, it is important to make correct decisions to achieve your goals. This is because growth in investment requires time and once you end up making a wrong investment decision, you cannot reverse it. Therefore, it is important to make use of the utilities smartly that you have in hand and step ahead to make the right investment decisions. Are you using the CAGR calculator? If not, then begin now!