Absolute Return vs CAGR

Discover the differences between Absolute Return and CAGR for informed investment decisions.
Absolute Return vs CAGR
3 min
02-May-2024

Mutual Funds have become one of the most popular investment instruments for investors, especially for those who want to invest systematically over time. The total SIP contribution by investors from April 2023 to February 2024 stood at a staggering Rs 1,99,219 crore, establishing mutual funds as an effective investment instrument within a balanced asset allocation plan.

However, investors face a dilemma when it comes to choosing a mutual fund scheme, as they have to choose from hundreds of Mutual Fund schemes. They all come with different terms and features, such as minimum investment, risk profile, fee and costs, etc. Most experienced investors compare various mutual fund schemes by considering the fund’s return potential. For that, they have a proper understanding of absolute return vs CAGR.

CAGR takes into account how long you've held an investment and helps calculate its yearly growth rate. On the other hand, absolute return focuses solely on the initial and final values of the investment.

If you are looking to invest in a mutual fund, it is important to understand absolute return vs CAGR to ensure that you can calculate the returns on your future mutual fund investments.

What are Absolute Returns in a Mutual Fund? 

The first factor in understanding absolute return vs CAGR is absolute returns. Absolute returns refer to the total returns provided by a particular mutual fund scheme on the initial investment amount, expressed in percentage terms. Absolute returns depict the initial investment's increased or decreased monetary value over a specific period.

Absolute returns do not factor in the tenure of the investment but focus on two factors: the initial investment (principal amount) and the final amount (maturity amount). Furthermore, absolute returns do not compare the returns to any benchmark or index and can be positive or negative.

The formula for absolute returns is:

Absolute Returns (in %): [(Current investment value/Initial investment amount)] x 100

What is the Compound Annual Growth Rate (CAGR) in a Mutual Fund?

The second factor in understanding absolute return vs CAGR is the Compound Annual Growth Rate (CAGR). The CAGR refers to the rate of return for an investment made in a mutual fund scheme over a specific period, depicted in percentage terms. CAGR provides an assumptive growth rate at which your initial investment will grow on an annually compounded basis, given that the profits are reinvested.

Since CAGR provides the rate of return on an annually compounded basis, it is also known as annualised return. Hence, there is no difference between annualised returns and CAGR. CAGR is useful for investors as it provides a year-by-year rate of growth for a mutual fund investment, showing the maths behind the investment reaching its current value.

The formula for Compounded Annual Growth Rate (CAGR) is:

CAGR (in %):  [(Ending value/ Beginning value) ^ (1/n) – 1] x 100

Here, n is the tenure of investment in years.

Difference between Absolute Return and CAGR

Now that you have understood the basic definitions and formulas of absolute returns and CAGR, the next factor in absolute return vs CAGR is to understand the detailed side-by-side difference. Here is the difference between absolute return vs CAGR:

Particulars

Absolute Returns

CAGR

Aim

To show the absolute or total returns from the initial investment value to the current value, irrespective of the holding period.

To show the annualised returns on the principal investment for a specific holding period through an annualised compounded rate, assuming profits are reinvested.

Formula

[(Current investment value/Initial investment amount)] x 100

[(Ending value/ Beginning value) ^ (1/n) – 1] x 100

Benchmark Comparison

No comparison to benchmark/index

Often compared to benchmark/index

Suitability

Better suited to calculate returns for holding periods less than a year.

Better suited to calculate returns for holding periods over one year.

 

Example for Absolute Return and CAGR

For a better understanding of absolute returns and CAGR, here is a detailed example:

You invested Rs. 20,000 in a mutual fund scheme, and its current value after five years is Rs. 35,000.

Absolute Returns (in %):  [(Current investment value/Initial investment amount)]x100

= [(35,000 - 20,000) / 20,000] x 100

= [(15,000) / 20,000] x 100

= 75%

So, the absolute return on your investment over five years is 75%.

CAGR (in %):  [(Ending value/ Beginning value) ^ (1/n)] – 1

= [(35,000 - 20,000) ^ (1/5) - 1] x 100

= [(1.75) ^ (0.2) - 1] x 100

= [1.1487 - 1] x 100

= 14.87%

  • Absolute Return indicates that your investment grew by 75% in rupee terms over the five years, increasing by Rs. 15,000.
  • A CAGR of approximately 14.87% indicates that your investment has grown at a constant rate each year.

CAGR Vs Absolute Return – Which is Better?

Having understood everything about absolute returns and CAGR, you know that CAGR and annualised returns are the same, and there is no difference between CAGR and annualised returns. However, both absolute returns and CAGR are beneficial in determining a mutual fund’s returns.

If your holding period is less than a year, absolute return is a better metric to use when calculating the return from your investment. However, CAGR makes up for a better calculation metric for mutual fund investments with a holding period longer than one year.

If you are looking to invest in mutual funds, the Bajaj Finserv Mutual Fund Platform is a one-stop solution with over 1,000 mutual fund schemes to choose from. You can choose how to invest in mutual funds i.e. through SIPs or invest a lump sum amount and see your investments grow.

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Frequently asked questions

What is the difference between CAGR and total return?

Although conceptually the same, CAGR and annualised returns differs as CAGR is showcased using the initial and ending investing values. On the other hand, annualised return is calculated by using the returns from multiple years.

How do you convert absolute return to CAGR?

If you have absolute returns, you just have to determine the holding period (N) along with the initial and final investment amount. Then, you can either use the formula or use the CAGR return calculator online to calculate CAGR.

What is the difference between XIRR and absolute return?

If your MF investments are through SIP, you need XIRR to calculate the returns as the mutual fund units and investment period vary significantly over time. Absolute return refers to the actual increase or decrease in the value of the investment over a specific period, expressed as a percentage.

Is 20% CAGR possible?

Yes, some mutual funds in the flexi cap, equity, midcap and multicap category have generated more than 20% CAGR. You can compare and analyse them based on their CAGR and other factors and invest for good returns.

What is the rule of 72 for CAGR?

The Rule of 72 is a simple mathematical formula used to estimate the number of years it will take for your investment to double at a fixed annual rate of return. You can apply this rule by dividing 72 by the annual rate of return.

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