Tracking how your investment grows over time is key to making informed financial decisions. Irrespective of whether you are putting your money in bonds, mutual funds, stocks, or fixed deposits, it’s important to measure not just how much your money has grown, but how consistently it has grown each year.
This is where Compounded Annual Growth Rate (CAGR) comes in. It is a standard metric used to evaluate the average annual return of an investment over a period of time, assuming the gains are reinvested. CAGR—unlike simple return figures—smooths out short-term volatility and gives you a clear view of long-term performance.
In this guide, we’ll explain what is CAGR, how it works, how to calculate it with a simple example, and when it’s most useful, especially in mutual fund investments.
What is CAGR?
CAGR stands for Compounded Annual Growth Rate. It is a widely used metric to measure the average annual return of an investment over a fixed time period. If you are asking what is CAGR, it is the rate at which your investment would have grown annually if it had grown at a steady pace every year.
In simple terms, CAGR shows how much an investment grows on average per year, smoothing out the effect of market ups and downs.
You will often come across this metric in mutual fund reports, stock analysis, and goal-based investment planning. If you’re trying to understand what is CAGR in mutual fund, it refers to how much your one-time investment in a fund has grown annually over a specific time horizon.
How is CAGR Calculated?
The formula to calculate CAGR is:
CAGR = (Ending Value / Beginning Value) ^ (1 / n) – 1
Where:
- Beginning Value = the amount you initially invested
- Ending Value = the value of your investment at the end of the period
- n = the number of years you stayed invested
Step-by-Step Example
Let’s say you invested ₹1,00,000 in a mutual fund, and after 5 years, the value becomes ₹1,76,000.
- Divide the ending value by the beginning value
= 1,76,000 / 1,00,000 = 1.76
- Take the 5th root of 1.76 (since n = 5 years)
= 1.76 ^ (1/5) = approximately 1.1195
- Subtract 1 and convert to a percentage
= (1.1195 – 1) × 100 = 11.95% CAGR
This means your investment grew at an average rate of 11.95% per year over 5 years.
Why Is CAGR Useful?
- CAGR smooths out volatility: It gives you a clean, annualised figure even if your investment saw ups and downs over the years.
- It helps compare different investments that were held over varying periods.
- It is widely used in reports and mutual fund dashboards because of its clarity and simplicity.
If you are evaluating long-term performance, knowing what is CAGR growth will help you make more balanced decisions, without getting distracted by short-term fluctuations.
What is CAGR in Mutual Funds?
CAGR in mutual funds is the compounded annual growth rate of your investment over a specific period. It shows how much your lump sum investment has grown on average per year, assuming the returns are compounded annually.
Application of CAGR in Mutual Fund Returns
If you invest a one-time amount in a mutual fund and stay invested for a few years, CAGR helps you measure the fund’s performance over that period. It does not show year-by-year returns but gives a smoothed annual return, making it useful for evaluating long-term consistency.
When to Use CAGR for Evaluating Fund Performance
Use CAGR when:
- You have made a lump sum investment.
- You want to compare two or more mutual funds over the same time frame.
- You are analysing fund performance over a fixed period (e.g., 3-year or 5-year CAGR).
Example: How CAGR Helps Compare Mutual Funds
You invest ₹1,00,000 in two different mutual funds. Fund A grows to ₹1,60,000 in 4 years and your CAGR is 12.47%. Similarly, fund B grows to ₹1,50,000 in 3 years and your CAGR is 14.47%
Even though Fund A gave higher absolute returns, Fund B delivered higher annualised growth. This shows why CAGR in mutual funds is a better measure for comparing funds over different periods.
What is a Good CAGR?
There’s no universal benchmark for what is a good CAGR, but generally:
- 8–10% CAGR is considered reasonable for conservative equity funds.
- 12–15% CAGR is seen as strong for aggressive growth mutual funds.
- In fixed income, anything above 6–7% CAGR may be competitive but this depends on the interest rate environment.
Always compare CAGR in context, with the risk, asset type, and investment horizon clearly understood.
Where CAGR is Useful and Where It’s Not
Some ideal use cases of CAGR are:
- Long-term, lump-sum investments: If you invest a single amount and leave it untouched for several years, CAGR is the most suitable way to measure how your investment grows annually.
- Performance comparison: CAGR helps you compare the performance of different mutual funds, stocks, or portfolios over the same time period — even if their actual year-on-year returns vary.
In contrast, CAGR is not ideal for:
- SIPs or irregular cash flows: CAGR does not account for multiple investments made at different times or varying amounts. If you’ve invested through SIPs or made partial withdrawals or top-ups, CAGR can give a misleading return figure.
In such cases, you should use XIRR (Extended Internal Rate of Return), which considers the timing and size of each transaction and gives a more accurate annualised return.
Besides XIRR, other useful return measures include:
- Absolute returns: Shows total growth but doesn’t annualise it.
- Rolling returns: Helps analyse consistency across time periods.
- Volatility-adjusted returns: Like the Sharpe Ratio to compare returns relative to risk.
Pros and Cons of Using CAGR
Some pros and cons of using CAGR as a metric are:
- Pros:
- Simple and easy to compare: CAGR gives a single, annualised return figure which makes it straightforward to compare different investments over the same period.
- Removes year-on-year fluctuations: It smooths out short-term volatility and shows the average growth rate, which lets you focus on the overall trend rather than short-term highs or lows.
- Cons:
- Doesn’t show volatility: CAGR hides the actual ups and downs that occurred during the investment period. Two investments with the same CAGR may have had very different risk profiles.
- Not suitable for multiple cash flows: CAGR assumes a single investment at the start and one redemption at the end. It does not account for SIPs, withdrawals, or top-ups, where XIRR would be more appropriate.
Conclusion
CAGR (Compounded Annual Growth Rate) is a widely used metric that shows the average annual return of a lump sum investment over a fixed period. It simplifies performance tracking by removing short-term volatility and providing a clear, annualised growth figure.
As an investor, you should use CAGR as a baseline tool to compare investments and assess long-term performance. However, it’s important to remember that CAGR is just one of many metrics. For a more complete view—especially when dealing with SIPs or irregular cash flows—consider using XIRR and other indicators alongside CAGR. This balanced approach leads to better and more informed investment decisions.
FAQs
What is the meaning of CAGR in mutual funds?
CAGR (Compounded Annual Growth Rate) in mutual funds refers to the average annual growth rate of a lump sum investment over a specific period. It shows how consistently your investment has grown each year, assuming the profits are reinvested.
How do you calculate CAGR manually?
You can calculate CAGR using the formula:
CAGR = (Ending Value / Beginning Value) ^ (1 / Number of Years) – 1
It gives you the annualised return. For example, if your investment grew from ₹1,00,000 to ₹1,44,000 in 3 years:
CAGR = (1,44,000 / 1,00,000) ^ (1/3) – 1 = 12.97%
Is a 12% CAGR good for long-term investing?
Yes, a 12% CAGR is generally considered a good return for long-term equity investing, especially when compared to traditional options like FDs or savings accounts. However, it also depends on the risk involved and the market conditions.
What is the difference between CAGR and XIRR?
The key difference is how they treat cash flows. CAGR assumes a single investment at the start, while XIRR accounts for multiple or irregular cash flows, such as SIPs or withdrawals, along with their exact dates. XIRR is better for tracking real-world investment behaviour.
Can CAGR be used for SIP returns?
No, CAGR is not suitable for SIPs or investments with multiple transactions. It does not consider the timing or amount of each contribution. For SIP returns, you should use XIRR, which accurately reflects the return based on all cash flows.
Disclaimer
The information provided in this article is for educational and informational purposes only. It should not be considered as financial or investment advice. Investing in stocks involves risk, and it is important to conduct your research and consult with a qualified financial advisor before making any investment decisions. The author and publisher are not responsible for any financial losses or gains that may result from the use of this information.
