If you invest, you would naturally want to know the returns they make over the years. We use something called compound annual growth rate or CAGR to calculate the rate of growth over time. The process involves complex calculations. So, it is always wise to take the help of an online CAGR calculator.
What is compounding?
While investing, it’s necessary to understand how compounding works. Although a CAGR calculator saves you the hassle, yet it is useful to know. Let’s say you have invested Rs 10,000 in a fixed deposit at an interest rate of 10 per cent for three years.
Initial capital = Rs 10,000
Capital at the end of year one = [10,000 + (10,000 x 10 per cent)] = 11,000
Capital at the end of year two = [11,000 + (11,000 x 10 per cent)] = 12,100
Capital at the end of year two = [12100 + (12,100 x 10 per cent)] = 13,310
The formula for calculating compound growth is as follows:
C = P x (1+r)n
C = Compounded value of the amount
P = Initial amount
R = Interest rate
N = Length or time of investment
In the above example, the compound growth rate would be 21 per cent.
What is CAGR?
Calculating CAGR is easy if returns are constant like those in case of a fixed deposit. However, things become complicate when returns vary from one year to another. For example, when you invest in equity, you may earn returns of five per cent a year, 30 per cent the next year, and zero in another year. In such situations, the CAGR calculator comes in handy.
Why would you need a CAGR calculator?
If returns vary, you will want to know how your investments fared each year on an average. It is helpful as you can use this particular calculator to find out how returns on different types of investment options compare and use it to reshuffle portfolios. For instance, if the CAGR on your mid-cap mutual funds for three years is 20 per cent and that on large-cap funds is only 10 per cent, you may want to put more of your money in mid-cap funds and divest some of your large-cap funds.
There is a formula for calculating the compound annual growth rate. You don’t need to know it and can rely on a calculator. However, it is interesting to see how the entire thing works. When you doubt results given by the CAGR calculator online, you can do the math yourself.
Here’s the formula:
CAGR(t0, tn) = [V(tn)/V(t0)]1/tn-to – 1
V(t0) = Original value
V(tn) = End value
tn-t0 = Number of years
Let’s say you have invested Rs 10,000 in stocks whose value has become Rs 25,000 at the end of five years. So, what’s the CAGR?
CAGR = (25000/10000)1/5 – 1 = 0.2, or 20 per cent.That looks difficult! It’s, therefore, better to stick to a compound growth calculator!
Here’s a word of warning before you fall back upon CAGR calculators. It’s just an average of annual growth rates over time. In a volatile situation, it may not give you an accurate picture of the worth of your investment. If you make 0 per cent returns in one year and 50 per cent the next, the average will be 25 per cent! An online CAGR calculator is a tool among many to help you make sound investments. Don’t rely on them entirely!
While using a CAGR return calculator, you have to enter the following details; the value of the investment at the start, the end value, and the number of years.
At times, people get concerned over a good CAGR. Are you worried too? Generally, there is no hard and fast rule for a good compound annual growth rate. However, if you have invested either in stocks or mutual funds, and the online CAGR calculator shows anything between 18 to 25 per cent, you are doing well.