CAGR vs Absolute Returns: A Detailed Comparison for Mutual Fund Investors

When investing in mutual funds, understanding your returns is essential to make informed decisions. Two key metrics that investors often come across are Compound Annual Growth Rate (CAGR) and Absolute Returns. Both are useful in evaluating the performance of mutual fund investments, but they serve different purposes and are calculated in different ways. In this blog, we will break down the differences between CAGR and Absolute Returns and how they can affect your investment strategy in the Indian share market.

What is CAGR?

CAGR (Compound Annual Growth Rate) is the rate at which an investment grows annually over a specified period, assuming the profits are reinvested at the end of each period. It is often considered a more accurate measure of an investment’s growth rate because it takes into account the effect of compounding over time. CAGR is especially useful when you want to evaluate the long-term performance of an investment.

CAGR Formula:

CAGR=(EndingValue/BeginningValue)^(1/n)−1

Where:

n is the number of years.
Ending Value is the value of the investment at the end of the period.
Beginning Value is the value of the investment at the start of the period.

Example of CAGR Calculation:

Let’s say you invested ₹1,00,000 in a mutual fund and the value after 3 years grew to ₹1,60,000. The CAGR for your investment would be:

CAGR=(1,60,000/1,00,000)^(1/3)−1=0.165 or 16.5%

This means that your investment grew at an average annual rate of 16.5% over 3 years.

What are Absolute Returns?

Absolute Returns is a straightforward metric that calculates the total return on an investment over a period without taking into account the time factor. It simply measures the percentage change in the value of the investment from the initial amount to the final amount, regardless of how long the investment was held.

Absolute Returns Formula:

AbsoluteReturns=((EndingValue−BeginningValue)/BeginningValue)×100

Example of Absolute Returns Calculation:

Using the same example where you invested ₹1,00,000, and the value increased to ₹1,60,000, the absolute return is:

AbsoluteReturns=((1,60,000−1,00,000)/1,00,000)×100=60%

In this case, your investment generated a total return of 60%, but Absolute Returns do not specify how long it took to achieve this return.

CAGR vs Absolute Returns: Key Differences

Aspect	CAGR	Absolute Returns
Time Factor	Takes the time period into account	Does not consider the time factor
Compounding	Assumes profits are reinvested	Does not assume reinvestment
Usage	Ideal for long-term investments	Suitable for short-term investments
Representation	Reflects annualized growth	Reflects total growth
Interpretation	Provides a smoother growth rate	May appear inflated over longer periods

When to Use CAGR and When to Use Absolute Returns

Use CAGR for Long-Term Investments
CAGR is the preferred metric for evaluating investments that are held for long periods (more than a year). It gives a clearer picture of how an investment has performed on an annual basis, accounting for the effect of compounding. For mutual fund investors, CAGR is particularly useful in comparing the performance of different funds over the same time period.
Use Absolute Returns for Short-Term Investments
If you are evaluating the performance of an investment held for a short period (less than a year), Absolute Returns is more appropriate. It provides a snapshot of the total gains or losses without considering the compounding effect.

Historical Data Comparison: CAGR vs Absolute Returns

Let’s consider a hypothetical investment of ₹1,00,000 in a mutual fund, with its value fluctuating over the years:

Year	Beginning Value (₹)	Ending Value (₹)	Absolute Return (%)	CAGR (%)
1	1,00,000	1,20,000	20%	20.0%
2	1,20,000	1,50,000	25%	22.5%
3	1,50,000	1,80,000	20%	21.1%
4	1,80,000	2,00,000	11.1%	18.9%
5	2,00,000	2,40,000	20%	18.4%

In the above table, the Absolute Returns show how much the investment increased each year. The CAGR smoothens these returns and provides a clearer picture of annualized growth over the period.

The Importance of Time in Measuring Returns

Time plays a critical role in measuring returns, which is why both CAGR and Absolute Returns have their own significance.

CAGR gives you an idea of how the investment grew annually on average, accounting for the effects of compounding. It is especially useful when comparing the performance of investments over long periods.
Absolute Returns tell you how much the investment has grown in total, but it doesn’t indicate how fast or slow the investment reached that point.

For example, an investment with a 60% absolute return over five years might sound impressive. However, if you calculate the CAGR, it could be a modest annual growth rate compared to other investment opportunities.

Pros and Cons of Using CAGR

Pros:

Considers Time: CAGR is one of the best ways to measure annual growth over a long period.
Smoothed Return: It evens out the volatility and provides a consistent measure of growth.
Comparison-Friendly: Makes it easy to compare the performance of various mutual funds or stocks over the same time frame.

Cons:

Doesn’t Capture Volatility: CAGR shows the average return and ignores short-term fluctuations.
Not Useful for Short-Term Investments: For investments held for less than a year, CAGR may not provide an accurate picture.

Pros and Cons of Using Absolute Returns

Pros:

Easy to Calculate: Simple and quick to calculate, requiring only the initial and final values.
Useful for Short-Term Investments: Ideal for evaluating returns on short-term investments or time-bound projects.

Cons:

Ignores Time Factor: It doesn’t account for how long it took to generate the return.
No Compounding Effect: Absolute Returns overlook the power of compounding, which is a key factor in long-term investing.

How CAGR and Absolute Returns Affect Mutual Fund Evaluation

Mutual funds often present their performance data in both Absolute Returns and CAGR. As an investor, understanding these figures is crucial for making well-informed decisions.

If a mutual fund shows an absolute return of 50% over 5 years, the CAGR might only be around 8.5%, which gives a more realistic view of the investment’s annual growth rate.
For example:

Let’s say you are evaluating two mutual funds with the following performance:

Mutual Fund	5-Year Absolute Returns (%)	5-Year CAGR (%)
Fund A	100%	14.87%
Fund B	80%	12.47%

While Fund A has a higher absolute return, both CAGR figures show that Fund B also provides consistent annual growth. Therefore, CAGR allows investors to assess long-term consistency in returns, whereas Absolute Returns focus on the overall gain.

Table: Absolute Returns and CAGR for Top Indian Mutual Funds (2020-2023)

Mutual Fund Name	3-Year Absolute Return (%)	3-Year CAGR (%)
Axis Bluechip Fund	55.36%	15.76%
SBI Small Cap Fund	67.29%	18.77%
HDFC Equity Fund	52.12%	14.91%
ICICI Prudential Value Fund	59.43%	16.77%
Kotak Standard Multicap Fund	48.57%	13.94%

This table shows how different mutual funds performed over a 3-year period using both Absolute Returns and CAGR. Investors can use these metrics to determine which fund aligns best with their investment goals.

Conclusion: Choosing Between CAGR and Absolute Returns

Both CAGR and Absolute Returns are valuable metrics, but they serve different purposes. While Absolute Returns provide a snapshot of total gains, CAGR offers a more nuanced, time-adjusted picture of annual growth. Investors should consider both metrics when evaluating mutual funds, particularly for long-term investments where the compounding effect plays a significant role.

When making investment decisions, it is essential to understand the advantages and limitations of each metric. Use CAGR for a long-term, steady perspective on growth, and rely on Absolute Returns for short-term investments where the overall gain matters more than the time taken.