Absolute Return vs CAGR - Difference and Which is Better (2024)

Absolute return and compound annual growth rate (CAGR) are essential metrics for evaluating investment performance. While absolute return measures the total percentage change in an investment's value over a specific period, CAGR calculates the average annual growth rate, accounting for compounding effects. Absolute return is ideal for short-term comparisons, while CAGR is more suitable for long-term analysis and comparing investments with varying durations.

To gain a comprehensive understanding of an investment's performance, it is crucial to consider both absolute return and CAGR. In this article, we will delve into the distinctions between these metrics, their calculation methods, and their significance in investment decision-making.

What are Absolute Returns in a Mutual Fund?

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 compound annual growth rate (CAGR)?

TheCAGR 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:

Use annual returns for long-term financial goals

Annualised returns are a cornerstone of long-term financial planning. When pursuing objectives such as retirement, education funding, or wealth accumulation, understanding the average annual growth rate of investments is paramount. By analysing annualised returns, investors can effectively gauge the performance of their portfolios over time, accounting for compounding effects.

The uses of CAGR

Compound Annual Growth Rate (CAGR) offers several advantages. It standardises the evaluation of investment success by providing a comparable metric based on average annual growth rather than absolute figures. CAGR facilitates long-term planning by projecting future values and aiding investors in making informed decisions. Additionally, CAGR can be used to assess investment risk. A consistently positive CAGR over time indicates steady, reliable growth, making it appealing to risk-averse investors.

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.

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