Absolute return and compound annual growth rate (CAGR) are two important metrics to evaluate your investment performance. You might be thinking what do these terms mean or more importantly, how do they affect your investment? Here is when a lumpsum calculator can be useful. It shows you the potential returns on your mutual fund investments. Before you use one, let’s break it down to simply the process.
What are absolute returns and CAGR?
Suppose you invested ₹1,00,000 in a mutual fund and after three years, it grew to ₹1,50,000. The first thing you’d want to know is how much you have earned. There are two ways to look at this.
- Absolute returns
Absolute returns show the total gain or loss on a mutual fund investment over a set period. This is the simplest way to calculate profit. You subtract the initial investment from the final value and express it as a percentage.
The formula is (Final Value – Initial Investment) / Initial Investment × 100
In our example (1,50,000 – 1,00,000) / 1,00,000 × 100 = 50%
That means your investment has grown by 50% in three years. Sounds great, right? Although the catch here is the number does not tell you how consistently the investment grew each year.
- CAGR
This helps you understand your investment’s average yearly growth rate over time. It considers compounding and shows the real rate at which your investment has grown yearly.
The formula is (Final Value / Initial Investment) ^ (1 / Number of Years) – 1 × 100
By using the same example: (1,50,000 / 1,00,000) ^ (1/3) – 1 × 100 = 14.47%
This means your investment grew at an average rate of 14.47% per year. Unlike absolute returns CAGR gives a clearer picture of long-term performance.
Why do CAGR and absolute returns matter?
When checking mutual fund performance many investors make the mistake of only looking at absolute returns. But that’s not enough.
- If your investment is short-term (less than a year), absolute returns make sense.
- For long-term investments (more than a year), CAGR is more reliable because it factors in compounding.
CAGR makes it easier to compare various investments. A fund with a 100% return in five years can look better than one with 80% in three years. But when you calculate CAGR, you get a clearer comparison.
How can a lumpsum calculator help you?
Now, here is how a lumpsum calculator can make things easier. Instead of doing all these calculations manually, you just enter:
- The amount you want to invest
- The expected rate of return
- The investment duration
For example, you invest ₹5,00,000 in a mutual fund with an expected 12% return per year for 10 years. A lumpsum calculator will show you:
- Resultant invested: ₹1,551,371
- Estimated amount: ₹1,051,871
- Amount invested: ₹499,500
You can now compare this with other investments and make an informed decision.
When should you use a lumpsum calculator?
- Before investing to get an estimate of how much your investment can grow.
- While comparing mutual funds to see which one offers better long term returns.
- To help you plan financial goals. Whether you’re buying a house or saving for retirement, a lumpsum calculator gives clarity. It helps you plan with realistic growth expectations.
These calculators help take the guesswork out of investing. Instead of randomly picking a fund, you get a clear idea of potential returns.
A common mistake investors make
Many investors assume a fund with high past returns will keep performing the same way. But past returns don’t guarantee future results. That’s why checking CAGR over 3, 5, or 10 years is important before deciding.
Be cautious of extremely high CAGR values. A fund showing 40% CAGR in one year can seem enticing, but was it due to market trends or real growth? This is why using a lumpsum calculator is a smart way to check if the fund’s growth aligns with realistic expectations.
To conclude, next time you plan an investment, take a minute to check the potential returns. This simple step ensures you make the right financial choices for your future.
References
