CAGR (Compound Annual Growth Rate) is a rate which shows how much a person’s investment grows over a specific period. In other words, it is the average returns an investor has earned on the investments after a given interval say one year.
This tool is very important because it helps in comparing two different returns from two investments, you can calculate how much an investment has returned per year on compounded basis, It's just the opposite of Compound Interest.
A = Final amount
P = amount invested
n = Number of years
CAGR can be a great tool to compare two different investments and there returns.
A. 10,000 invested in a XYZ mutual fund for 2 yrs became 20,000
B. 50,000 invested in GOLD for 7 years became 4,00,000
The compound annual growth rate (CAGR) are applied at various places of personal finance. It is often used to calculate the average growth of single investment over a certain period. CAGR can be applied in comparing return on equity with bonds or saving accounts. Further, it can be used to compare the performance of two companies and forecasting their future growth based on their historical data.
With simple growth rate one can see how much their investment is going to yield within it's time horizon. In simple words we can same that formula of simple growth rate can be used to determine the percentage increase of a value within a particular period of time, which is usually the same as the whole investment period (e.g., three years, ten months, etc.)
And with CAGR, we can say that it is a rate that shows the average rate of return required for an investment to grow from its initial balance to its final balance within the particular period on a yearly basis.
The time horizon of investment doesn't matter with CAGR. Unlike the simple growth rate, the compound annual growth rate enables you to compare investments with different time horizons.
How can an investor know the performance of a particular mutual fund or whether investing in the particular mutual fund is of worth or not?
Investor can gauge the performance of a particular mutual fund or know whether the investment in particular fund is worth or not through the calculation of CAGR. CAGR puts the concept of compound interest and makes it easier to see the annual growth rate of the fund. CAGR is useful in mutual fund industry in determining the performance of mutual fund and whether investing in the fund is of worth or not.