Prior to proceeding with the fund investments, one can easily gain information on both returns and losses. Yet, getting solely an increased or decreased number is not equivalent to the full picture. Rather, one needs to be clear about the associated intricacies. With this, we mean that while both absolute returns and CAGR offer insight into the returns obtained from mutual funds, knowing their difference is essential to finding the optimal one suited for your investment goals.

Understanding what these two are and their differences will assist in informed decision-making. So, read on.

Understanding Absolute Returns

Absolute returns refer to the total return obtained on an investment. It is indicative of an overall increase or decrease in funds as it is calculated based on the pure performance of an investment. This means that absolute investment only considers the initial and final amounts. Different strategies exist to ensure positive absolute returns in an investment, which include short selling and the use of derivatives.

The formula for calculating absolute returns includes the following:

Absolute Returns (%) = [(Current Value / Initial Investment Value) − 1] × 100

Let’s understand this with an example.

A person invests INR 1 lakh and gets INR 1,90,000 in return. The absolute returns in this case will be:

Absolute returns = [(1,90,000/1,00,000)-1]x100

Absolute returns = [(1.9-1)]x100

Absolute returns = 90%

Absolute returns offer insights into possible returns from the investment. However, it lacks specific details, such as the time of investment and the growth potential. Hence, CAGR is another metric that provides a detailed comparison of mutual fund returns.

Understanding CAGR

Compound Annual Growth Rate or CAGR refers to the returns in percentage obtained in a specific period. It can also be considered as the assumptive growth rate of investment based on annual compounding. Based on yearly compounding, the obtained rate of return is also known as an annualised return. The measurement offers a better comparison of different returns gained over different time periods. The year-by-year rate of growth is effective information for decision-making.

The formula for calculating CAGR is:

CAGR (%) = [(Ending value/Beginning value)^(1/n)-1] x 100, where n is the tenure of investment in years.

Let’s understand this with the previous example.

A person invests INR 1,00,000 and gets INR 1,90,000 in return after 5 years. The CAGR in this case will be:

CAGR = [{(1,90,000/1,00,000)^(⅕)}-1]x100

CAGR = [{(1.9)^(⅕)}-1]x100

CAGR = 13.7%

The CAGR of 13.7% indicates a steady growth rate of INR 1,00,000 over 5 years to provide INR 1.9 lakhs.

Absolute Returns vs CAGR: Key Differences

Absolute Returns vs CAGR: Key Differences To help you gain more clarity, here is a mutual fund performance comparison with different aspects.

Right Choice Between Absolute Returns vs CAGR

The absolute returns and CAGR offer insights into investment performance. While absolute returns focus only on overall increase or decrease, the CAGR deals with specific periods of investment. The ideal one among the two depends on one's investment period and financial goals. The CAGR is better suited for investment in longer duration owing to its calculation of yearly increments over time. On the other hand, absolute returns are an effective option for investments that last less than one year. Hence, the optimal choice between the two depends on the period of investment.

Important Factors to Consider When Investing Based on CAGR

Some of the important factors to know about CAGR include:

• It is not the annual rate of return on investment amount.

• It does not consider market volatility.

• It is not useful for investments made through SIPs.

Conclusion

When informed about absolute returns vs CAGR, you must be aware of the key differences between the two. While absolute returns offer direct insights into increases or decreases in funds, the CAGR offers detailed information and provides a more accurate measure of compounding on multiple-year investments. Hence, understanding these two types of returns helps in mutual fund performance comparisons and developing strategies that align with one’s financial goals .

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.