What is the formula for calculating CAGR?
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CAGR can be calculated using a simple formula: CAGR= [{(Current amount/Initial amount)^(1/ tenure of the investment)} - 1] × 100
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CAGR vs Absolute Returns
By Bajaj Broking Team
March 18, 2025
8 mins read
Investment
When it comes to investments, one of the most crucial aspects is assessing your returns on the same. Now, there are several ways to gauge the returns on your funds, and Absolute Returns and CAGR or Compound Annual Growth Rate are two common measures to do the same.
Both CAGR and absolute returns are used in different perspectives to make better, informed decisions about your returns, investments, and overall financial planning. For example, CAGR can come in handy to compare different investments, gauge long-term growth, and more. Alternatively, absolute returns can be an effective tool to measure short-term growth. Thus, understanding the difference between CAGR vs Absolute returns can help investors better assess their investment’s performance. So, what are you waiting for? Continue reading as we explore the differences between Absolute returns vs CAGR, how to calculate them, their use, and much more in detail.
What is Absolute Return?
Before going any further and exploring the differences between these two measures, let's first understand what an absolute return is. Well, an absolute return can be simply understood as an investment's total return. It is generally expressed in terms of percentage. Your absolute returns simply showcase the performance of your initial investment, including how much it grew over a period of time.
The major focus areas of absolute returns are your final maturity value or final investment amount and your initial investment amount. This means the tenure of your investment isn't of much importance.
For example, say your certain investment has an absolute return of 15%. Now, this nowhere tells whether these 15% returns have been earned in several weeks or months. However, you can still gauge the growth and the performance of an investment.
How to Calculate Absolute Return?
Now that you know what absolute return is, let's move forward. Let's try and understand how to calculate absolute returns for analysing the performance of your assets.
You may easily calculate absolute returns using a simple formula, i.e., Absolute returns = [(current amount/initial amount)-1] × 100.
Let's say you made an initial investment amounting ₹2,00,000 and this grew to be a final or current amount of ₹2,50,000. Then, your absolute returns will be:
[(2,50,000/2,00,000)-1] × 100
= 25%
Here, the return on investment is 25%.
What is the Compound Annual Growth Rate (CAGR)?
Now, let's come to the next metric: CAGR or Compound Annual Growth Rate, also popularly called annualised returns. The CAGR comes in handy in understanding the returns on your investment over a period of time. Not only does it showcase the annual rate of growth of an investment, but you may also gauge how it reached the final value. This simplification makes CAGR quite an effective tool to analyse and compare different investments and monitor their performances.
Using CAGR, you can compare two different investment options and see which one offers better returns over a set period of time. Further, it also helps investors understand an investment’s potential as it generally avoids short-term market impact and volatility.
How to Calculate CAGR?
Now that you understand the meaning of CAGR, let's see how you may calculate it.
- You can easily calculate CAGR using the following formula:
- CAGR= [{(Current amount/Initial amount)^(1/ tenure of the investment)} - 1] × 100.
- Let's say your initial investment was ₹2,00,000. Now its performance in 3 years is given below:
- Year 1- 2,10,000
- Year 2- 1,90,000
- Year 3- 2,50,000
- Here, your initial investment of ₹2,00,000 grew to ₹2,50,000 over a period of 3 years.
- Now, the CAGR will be:
- [{(2,50,000/ 2,00,000)^(1/ 3)} - 1] × 100 = 7.72%.
Key Differences Between Absolute Return and CAGR
Now that you know the meaning of both: absolute returns and CAGR, let's try and explore their differences. The major difference between CAGR and Absolute returns lies in the consideration of specific periods. For instance, absolute returns take no consideration of the period of growth, alternatively, CAGR is calculated for a set period. Here is a table citing absolute returns vs. CAGR to help you quickly understand the differences between the two metrics.
Features | Absolute Returns | CAGR |
Objective | Showcase the total rise or fall in the value of investment. | Showcases the annual returns on investment over a specific period. |
Formula | Absolute returns = [(current amount/initial amount)-1] × 100 | CAGR= [{(Current amount/Initial amount)^(1/ tenure of the investment)} - 1] × 100 |
Accuracy meter | Considered comparatively less accurate to compare different investments of different periods | Known to offer better accuracy in comparing different investments of different periods. |
Suitability | Ideal for calculating ROI on investments held up to 1 year. | Ideal for calculating ROI on investments held for more than at least a year. |
Considering Factor | Investment tenure is not taken into consideration. | The investment’s tenure is taken into consideration. |
When to Use Absolute Return vs. CAGR?
Both the metrics, CAGR and absolute returns, are quite crucial tools in evaluating the performance of an investment. However, these can be used in different ways to understand your returns better.
Typically, CAGR is considered to be ideal when talking of long-term investments. Since CAGR is annualised returns, and gauges the annual growth rate of an investment over a specific period, it better showcases how your investment has changed every year, giving you detailed insights on its performance graph. Further, it can also be used to assess growth trends and future potential of investments and compare different investments.
Absolute returns, on the other hand, are simple metrics that can help you understand the change or difference in your current and initial investment. Thus, it is suitable for short-term investments held for less than one year, where you need straightforward results or simple comparisons.
Additional read - XIRR Vs. CAGR
Common Misconceptions About Investment Returns
Assessing investment returns is important to see if they are aligning with your financial planning and goals. However, it is important to calculate and evaluate them wisely and accurately instead of following common misconceptions around them. To ensure you do not fall prey to such misconceptions, consider having a look at some of them.
- Bigger Risks = Bigger Returns
Investors often think investments with a high-risk profile can help them earn higher profits. Now, this might be true in some cases, but there is no guarantee that bigger returns come with higher risks.
- Past Performance = Future Growth and Returns
Now, assessing the past performance of an investment is crucial for research. It helps understand its growth potential and more. However, there is no guarantee the future potential of a company solely depends on its past performance as the factors affecting the investment’s performance might change over a while.
- All Returns are Taxed the Same
There is a common misconception about investment returns that all of them are taxed the same. However, that isn't the case. For instance, dividends are taxed differently. Similarly, long-term capital gains are taxed differently and comparatively lower than short-term capital gains.
- Not Considering the Investment Costs
When thinking of overall returns, investors often tend to ignore all the other costs, like trading fees, transaction costs, and much more. It is important to assess and consider all these costs as they significantly impact the overall returns.
Practical Examples Illustrating Absolute Return and CAGR
As mentioned, both CAGR and Absolute returns are important metrics to evaluate the performance of your investments. Let's see how they work with the help of practical examples.
Absolute Returns:
It helps you understand the difference between your final and initial investment value.
Example: Say Kamal invested ₹10,000 in a stock and it grew to ₹12,000 over two years.
Absolute returns : [(current amount/initial amount)-1] × 100.
Meaning, the absolute returns for Kamal’s investment will be : [(12,000/10,000)-1]× 100
= 20%.
CAGR:
It helps you understand the annual performance of your investments over a specific period.
Example: Say Kamal invested ₹1,50,000. Its performance in 5 years is given below.
- Year 1: 1,52,000
- Year 2: 1,60,000
- Year 3: 1,40,000
- Year 4: 1,80,000
- Year 5: 2,20,000
Now, CAGR= [{(Current amount/Initial amount)^(1/ tenure of the investment)} - 1] × 100
Meaning, the CAGR here will be: [{(2,20,000/1,50,000)^(1 /5)} - 1] × 100
= 7.96%.
Tools and Calculators for Measuring Investment Performance
In addition to these two metrics, you can also use a variety of other tools and calculators to measure your investment’s performance. Consider having a look at some of these calculators.
- Mutual Fund Calculator
Using this calculator you may calculate your returns on different SIPs and other investments. This helps you plan your investment amount and expected return rate.
- Lump Sum Calculator
It offers you a potential average of your investments. You can use it to calculate compounded growth, investment earnings, and other figures.
- Investment Calculator
Considering factors like your initial investment, return rate, and more, you may use an investment calculator to evaluate the estimated growth of your investments.
In addition to these, you can also use other tools like return analysis tools and other online performance tools.
Conclusion
Both the metrics, CAGR and Absolute returns, are quite effective in calculating an investment’s performance. These have their own benefits, use, and accuracy based on the tenure of the tenure of the investment. However, to make the most out of these, it is important to understand both of them and their differences so that you know their ideal cases of use. Also, don't forget to consider your risk appetite and financial goals before making an investment choice.
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Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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Frequently Asked Questions
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In which scenarios is absolute return more useful than CAGR?
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Absolute return offers valuable insights into the overall difference between the final or the current value and the initial investment value. It is considered suitable for short-term investments and simple comparisons.
Can CAGR be applied to investments held for less than a year?
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CAGR can ideally be applied to investments that are held for over a year. For investments held less than a year, CAGR may not be very accurate.
How do market fluctuations impact absolute returns and CAGR differently?
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Market fluctuations have a significant impact on the absolute returns as they are directly showcased in the total profits or losses made at the end of an investment period. However, for CAGR, the market fluctuations are smoothened as it calculates the average growth rate on an annual basis. It emphasises the overall growth trend, thus reducing the impact of short-term market fluctuations.
Are there online tools to easily calculate CAGR and absolute returns?
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Yes, there are a variety of online tools that can help you easily calculate CAGR and absolute returns in just a few steps. Here, you simply need to put the initial investment amount, the investment tenure, and the final returns, and you can easily calculate your desired metric.
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