What is CAGR?
CAGR (Compound Annual Growth Rate) represents the constant rate at which an investment would have grown if it had grown at a steady rate each year. It is the most commonly used metric to measure and compare investment performance over time.
Unlike simple average returns, CAGR accounts for compounding and provides a "smoothed" annualized return that eliminates the effects of volatility. This makes it ideal for comparing investments with different time horizons.
CAGR Formula
Where:
- Final Value = Current or ending value of investment
- Initial Value = Starting or purchase value
- n = Number of years
CAGR Calculation Example
If you invested ₹1,00,000 and it grew to ₹2,50,000 in 5 years:
CAGR = (2.5)^(0.2) - 1
CAGR = 1.2011 - 1
CAGR = 0.2011 = 20.11%
CAGR vs Absolute Returns
| Metric | Formula | Use Case |
|---|---|---|
| Absolute Returns | (Final - Initial) / Initial × 100 | Quick snapshot of total gains |
| CAGR | (Final/Initial)^(1/n) - 1 | Comparing investments of different durations |
| XIRR | IRR with actual dates | Investments with multiple cash flows (SIP) |
Benchmark CAGR by Asset Class
| Asset Class | Average CAGR | Risk Level |
|---|---|---|
| Savings Account | 3-4% | Very Low |
| Fixed Deposits | 6-7% | Low |
| PPF/NSC | 7-8% | Low |
| Debt Mutual Funds | 7-9% | Low-Medium |
| Gold | 8-10% | Medium |
| Real Estate | 8-12% | Medium |
| Equity Mutual Funds | 12-15% | High |
| Nifty 50 (Long-term) | 12-14% | High |
| Small Cap Stocks | 15-20% | Very High |
Limitations of CAGR
- Ignores Volatility: CAGR smoothens actual returns and doesn't show risk/fluctuations.
- Not for Multiple Cash Flows: CAGR works only for single investment at start. For SIPs or multiple investments, use XIRR.
- Past Performance: High historical CAGR doesn't guarantee future returns.
- Ignores Dividends: Unless dividends are reinvested and included in final value.
Frequently Asked Questions (FAQs)
What is a good CAGR for mutual funds?
For equity mutual funds in India, 12-15% CAGR over 5+ years is considered good. Large cap funds typically deliver 10-12%, while mid/small cap funds can deliver 15-18% with higher volatility. Always compare against benchmark index.
How is CAGR different from average annual return?
Average annual return is arithmetic mean of yearly returns, while CAGR is geometric mean. Example: If returns are +50%, -20%, +30% over 3 years, average = 20%, but CAGR = 16.9%. CAGR is more accurate for compounding investments.
Can CAGR be negative?
Yes, CAGR will be negative if the final value is less than initial value, indicating the investment lost money. For example, ₹1 lakh becoming ₹80,000 in 2 years = -10.56% CAGR.
How do I calculate CAGR in Excel?
Use the formula: =((Final/Initial)^(1/Years))-1 or use the RATE function: =RATE(years,,-initial,final). Format result as percentage.
Should I use CAGR or XIRR for SIP?
Always use XIRR for SIP investments since you're investing different amounts at different times. CAGR is only accurate for lumpsum investments held for the entire period.