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Is CAGR Same as Compound Interest?
CAGR is one of the most important terms in the world of investing, particularly mutual fund investment.
It is often confused with compound interest, which is also a crucial part of mutual fund investments; but are these two terms the same?
Read on to find out more about CAGR and compound interest.
What is compound interest?
Albert Einstein famously declared compound interest to be the 8th wonder of the world.
Compound interest is the interest that is earned on an investment, which is the principal deposit + any accumulated interest earned.
This makes it an extremely powerful tool for creating wealth in the long run.
Investment vehicles like mutual funds make use of compound interest and that is why they are so popular for generating wealth in the long term.
Compound interest is great for investment instruments but will go against a person when paying interest on a loan.
How does compound interest work in investing?
There is a compound interest formula that is used to calculate the returns on investment. The formula is A = P x (1+r/t)^(nt)
- P is the principal of the investment
- r is the annual rate of interest
- n is the total number of times in the year when the interest amount is compounded
- t is the number of years
- A is the amount after t or the number of years
Suppose you make an initial investment of Rs 12,000 with an investment period of 9 years and an annual interest rate of 8%.
The total amount would be 12000(1+.08)^9 = 23988
With compound interest, your investment keeps growing and accelerating over time as you keep earning interest on increasingly larger balance amounts (your initial investment/deposit plus interest). Interest on an investment may be compounded at different intervals.
More frequent compounding will result in a more rapid growth of the principal amount.
It can be confusing and tedious to manually calculate the compound interest of your investments.
A Compound Interest Calculator is very handy to calculate these figures quickly and easily.
You can use the Compound Interest Calculator to check out the returns on different investments using different return rates and timespans.
A Compound Interest Calculator also figures out how much investment is needed to make over a specific timespan to achieve a certain financial goal.
What is CAGR?
CAGR or acronym for Compound Annual Growth Rate helps investors understand the compounded growth rate of their mutual fund investments.
With CAGR, investors can determine the average annual growth of a mutual fund investment over a specific period.
How does CAGR work in investing?
When it comes to mutual funds, the rate of return does not remain constant throughout. It varies over time according to market fluctuations.
Seasoned investors and financial experts use CAGR to figure out how much their investment has grown each year, especially when profits are reinvested into the fund.
The formula for CAGR is
- CAGR = (A/P)^(1/n) – 1
- A is the final amount
- P is the amount of money invested
- n is the number of years of investment.
Suppose you invest Rs 12,000 in the ABC mutual fund for 2 years, which became Rs 24,000.
You also invested Rs 60,000 in XYZ mutual fund for 8 years, which became Rs 5,00,000. So, which investment gave you better returns?
It can be hard to understand since the tenure and amount invested in the two mutual funds are different. This is where CAGR can help you understand which was the better investment.
- XYZ mutual fund = (24000/12000)^(1/2)-1
- CAGR is 41.42%
- ABC mutual fund = (500000/60000)^(1/7)-1
- CAGR is 35.38%
Here XYZ mutual fund was a better investment as it has a higher CAGR.
In this way, CAGR can be used to analyse the performance of different investments, compare mutual funds or stocks, and even track how well a business is doing.
It provides a detailed look at an investor’s return on investment (ROI).
You can compare your investment’s CAGR against a specific benchmark to understand if it is hitting the benchmark, falling below it, or outperforming the benchmark.
Calculation of CAGR can be tedious and you can make a mistake trying to manually calculate the CAGR. Instead, you can use a CAGR Calculator to make your calculations a breeze.
A CAGR Calculator saves you both the time and effort of manually calculating different CAGRs for various investments.
Investors should use a CAGR Calculator to figure out how much they should invest to maximise their returns over a certain period.
They should also use it to compare the ROI on different investments and make decisions based on the results.
Summing up:
Both compound interest and CAGR have their place in investing, but should not be mistaken for the other.
CAGR Calculators and Compound Interest Calculators are useful tools that can aid investors in analysing and making financial decisions about their investments.
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