CAGR (Compound Annual Growth Rate)

CAGR stands for Compound Annual Growth Rate.

It represents the mean annual growth rate of an investment over a specified period longer than one year, accounting for the effect of compounding. It is one of the most widely used metrics to compare the performance of different investments, especially mutual funds, stocks, and portfolio returns over multi-year periods. What is CAGR? The formula for CAGR is: (Ending Value / Beginning Value)^(1/n) - 1, where n is the number of years. If your mutual fund investment grew from ₹1 lakh to ₹2 lakhs over 5 years, the CAGR is (2/1)^(1/5) - 1 = 2^0.2 - 1 = 0.1487 = 14.87%. This means the investment grew at an average rate of 14.87% per year, compounded annually. CAGR is useful because simple average returns can be misleading. If a fund grows 50% in year 1 and falls 30% in year 2, the simple average is (50 - 30) / 2 = 10% per year. But if you invested ₹1 lakh, after year 1 you have ₹1.5 lakhs, and after year 2 at -30%, you have ₹1.05 lakhs — a 5% total gain over 2 years, which is a CAGR of only 2.47% per year, not 10%. In India, CAGR is commonly used to evaluate fund performance. When a mutual fund ad says "Schemes that delivered 18% CAGR over 5 years," it means the fund grew at an average of 18% each year compounded annually over that 5-year period. This is more meaningful than a single year's return because it smooths out volatility. However, CAGR has limitations. It does not account for the volatility of returns along the way. Fund A that returned 18% every single year and Fund B that returned 40% in year 1 and -4% for the next 4 years could both have a 5-year CAGR of 18%. For a more complete picture, investors should also look at standard deviation, maximum drawdown, and rolling returns. CAGR is best used for lumpsum investments with a defined start and end value. For systematic investments (SIPs) where you invest a fixed amount every month, XIRR is a better measure because it accounts for multiple cash flows at different points in time. Always use CAGR alongside other metrics to get a holistic view of investment performance.