Did you start investing after being inspired by the ‘Mutual Funds, Sahi Hai’ ad? You’re now wondering how to evaluate your mutual fund’s performance? You’re not alone. Two important metrics often used are CAGR and Absolute Returns. Let’s see what CAGR and absolute return mean in mutual funds, and understand which metric truly reflects your fund’s performance.
What is Absolute Return in Mutual Funds?
Absolute return in mutual fund investments refers to the total percentage change in your investment's value over a specific period. It's a straightforward calculation that shows you how much your investment has grown or declined in total, regardless of how long you've held it.
The formula for calculating absolute return is:
Absolute Return = ((Ending Value - Beginning Value) / Beginning Value) × 100
For example, if you invested ₹50,000 in a mutual fund, and after some time, its value increased to ₹75,000, your absolute return would be:
((75,000 - 50,000) / 50,000) × 100 = 50%
This means your investment grew by 50% during that period.
Absolute return in mutual fund evaluation gives you a clear picture of the total growth your investment has achieved.
However, it doesn't take into account how long it took to achieve that growth, which can be misleading when comparing different investment options.
What is CAGR in Mutual Funds?
CAGR, or Compound Annual Growth Rate, in mutual fund investments represents the annual rate of return that your investment has generated over a period longer than one year. It factors in the compounding effect and provides a smoothed annual growth rate.
The formula for calculating CAGR is:
CAGR = ((Ending Value / Beginning Value)^(1/n) - 1) × 100
Where "n" is the number of years.
Using our previous example, if that ₹50,000 grew to ₹75,000 over 3 years, the CAGR would be:
((75,000 / 50,000)^(1/3) - 1) × 100 = 14.47%
This means your investment grew at an average rate of 14.47% per year over the three-year period.
What is CAGR in mutual funds? It's essentially a way to measure the steady growth rate of your investment over time, making it easier to compare investments with different time frames.
CAGR in mutual fund performance evaluation helps smooth out the volatility and gives you a more standardised metric for comparison.
CAGR vs Absolute Returns: Understanding the Differences
When comparing CAGR vs Absolute Returns, several key differences emerge:
1. Time Consideration:
Absolute Return: Doesn't consider the time period of the investment
CAGR: Factors in the duration of the investment
Volatility Reflection:
Absolute Return: Doesn't show the ups and downs during the investment period
CAGR: Smooths out volatility to give an annual average
Comparison Capability:
Absolute Return: Difficult to use when comparing investments with different time periods
CAGR: Makes it easier to compare investments held for different durations
Investment Period:
Absolute Return: More suitable for investments held for less than a year
CAGR: Better for investments held for more than a year
Let's explore an example to understand CAGR vs Absolute Returns better: Suppose you have two mutual fund investments:
Fund A: ₹1,00,000 grew to ₹1,60,000 in 2 years
Fund B: ₹1,00,000 grew to ₹2,00,000 in 5 years
The absolute returns would be:
Fund A: 60% over 2 years
Fund B: 100% over 5 years
Just looking at absolute returns, Fund B might seem better with 100% growth compared to Fund A's 60%. However, when we calculate the CAGR:
Fund A: 26.5% per year
Fund B: 14.9% per year
Now we can see that Fund A actually performed better on an annual basis, highlighting why CAGR vs Absolute Returns analysis is so important for proper investment evaluation.
Test Your Knowledge1. If a mutual fund investment of ₹10,000 grows to ₹13,000 in one year, what is the absolute return? a) 30% b) 13% c) 3% d) 130% 2. An investment that grew from ₹50,000 to ₹86,450 over 5 years has what CAGR? a) 72.9% b) 14.6% c) 11.5% d) 36.45% 3. Which metric would be more appropriate for comparing two mutual funds where one was held for 6 months and the other for 4 years? a) CAGR b) Absolute Return c) Both are equally appropriate d) Neither is appropriate (Answers: 1-a, 2-c, 3-b) |
When to Use Absolute Return vs CAGR
After understanding what is absolute return and what is CAGR in mutual fund , let’s know when to refer to them:
Use Absolute Return when:
Evaluating investments held for less than a year
You want to know the total growth regardless of time
Comparing investments with identical time periods
Getting a quick snapshot of overall performance
Use CAGR when:
Analysing investments held for more than a year
Comparing investments with different time periods
You want to understand the annual growth rate
Evaluating the long-term performance of your portfolio
Misconceptions About CAGR & Absolute Returns
1. Higher Absolute Return Always Means Better Performance
Not necessarily. A 50% absolute return achieved over 10 years is less impressive than the same return achieved in 2 years.
2. CAGR Reflects Actual Annual Returns
CAGR provides an annualised average, not the actual return for each year. Your actual returns might fluctuate significantly from year to year.
3. Absolute Returns Are More Important Than CAGR
The importance depends on your investment horizon. For long-term investors, CAGR generally provides more meaningful insights.
FAQs on CAGR & Absolute Returns
Q) Which is better, CAGR or absolute return?
A) Neither is inherently ‘better’ - they serve different purposes. Absolute return shows total growth regardless of time, while CAGR normalises returns on an annual basis.
For short-term investments (less than a year), absolute return is more appropriate. For long-term investments and comparing options with different time frames, CAGR provides a more meaningful comparison.
Ideally, investors should look at both metrics to get a complete picture of performance.
Q) How do you convert absolute return to CAGR?
1. To convert absolute return to CAGR, use the formula:
CAGR = ((1 + (Absolute Return/100))^(1/n) - 1) × 100
Where "n" is the number of years.
For example, if your investment gave an absolute return of 50% over 3 years:
CAGR = ((1 + (50/100))^(1/3) - 1) × 100 = 14.47%
This calculation helps normalise the total return over the investment period into an annual rate.
Q) How much absolute return is good in mutual funds?
1. What constitutes a "good" absolute return depends on several factors:
The type of mutual fund (equity, debt, hybrid)
The market conditions during the investment period
Your investment goals and risk tolerance
The investment duration
Q) Should we look at XIRR or absolute return?
XIRR (Extended Internal Rate of Return) is actually more similar to CAGR than to absolute return, but it accounts for multiple cash flows at different times. When evaluating:
Single investments with no additional contributions or withdrawals: CAGR and absolute return are sufficient
Investments with multiple cash flows (SIPs, partial withdrawals): XIRR provides a more accurate performance measure
For most regular mutual fund investors making systematic investments, XIRR offers the most accurate picture of actual returns. Absolute return is still useful for understanding total growth, but it doesn't account for the timing of cash flows like XIRR does.
Start Your Investment Journey Confidently
Understanding what CAGR is in mutual fund performance and what absolute return is in mutual fund performance analysis helps you make more informed investment decisions. Here are some tips:
Use both metrics together: Look at absolute return for total growth and CAGR for annualised performance.
Compare with appropriate benchmarks: Assess your fund's CAGR against the benchmark index's CAGR for the same period.
Consider other factors: Don't rely solely on returns—consider risk measures, fund manager expertise, and fund objectives.
Match metrics to your investment horizon: For short-term goals, absolute returns matter more; for long-term goals, focus on CAGR.
By understanding the differences in both metrics, you'll be better equipped to evaluate fund performance and make investment decisions aligned with your goals.
Disclaimer: This information provided is intended for general informational purposes only. It is not a substitute for professional advice or guidance. For personalised recommendations or specific concerns, please consult a certified professional.
