Category: Personal Finance

Absolute Return vs. Average Rate of Return vs. CAGR

Absolute Return vs. Average Rate of Return vs. CAGR

In my previous video, I introduced my favorite financial tool — a CAGR Calculator. Today I’m comparing 3 kinds of returns: Absolute Return vs. Average Rate of Return vs. Compounded Annual Growth Rate (CAGR).

There are more kinds of returns namely: Relative Returns, Risk-Adjusted Return, Rolling Returns, Internal rate of Return(IRR), Extended Internal Rate of Return (XIRR), etc. But I believe Absolute Return, Average Rate of Return, and CAGR are the must-knows.

I have compared all the 3 kinds of returns using the same example. That is, I assumed that you bought a stock at Rs. 1,000 and sold it for Rs. 2,000 after 5 years. And then there’s a Onevestor thing. Because there’s another reason why I made this video and that’s the new Mutual Fund (or rather SIP) culture that’s happening in our country.

1. Absolute Returns

* Absolute Return is simply an asset’s return over a certain period.
* It actually ignores the timeframe.
* For e.g., let’s say you bought a stock for Rs. 100 and sold it for Rs. 200 after 5 years.
* Your absolute return here is 100%.
* Your absolute return is still 100% even if you sold it after 10 years.

2. Average Rate of Return / Simple Annualised Return

* A simple annualised return simply divides the rate or return for the period by the number of years in the investment period.
* It ignores the time value of money.
* For example, suppose an investment returns the following annually over a period of five full years: 10 percent, 15 percent, 10 percent, 0 percent and 5 percent. To calculate the average return for the investment over this five-year period, the five annual returns are added together and then divided by 5. This produces an annual average return of 8 percent.

3. CAGR

* CAGR shows how much a person’s investment grew in one year.
* It is the average returns an investor has earned on the investments after one year.
* As you can see, unlike absolute return, CAGR takes time value of money into account. As a result, it is able to reflect the true returns of an investment generated over a year.
* In other words, 1000+14.87%+14.87%+14.87%+14.87%+14.87% = 2,000.014320624
* 1000+20%+20%+20%+20%+20% = 2,488.32
* CAGR is crucial for any asset class. Here’s why.
* Suppose you invested Rs. 1000 in a stock. It gave 100% returns in first year and your stocks value becomes Rs. 2000.
* In second year, it falls 50% and that takes your stock value back to Rs. 1,000.
* Here CAGR and your Absolute Return = 0. But simple annualized return = 50/2=25%
* It represents one of the most accurate ways to calculate and determine returns for individual assets, investment portfolios and anything that can rise or fall in value over time.

* There’s another reason too –– why I explained all above types of returns.
* And it’s the new Mutual Funds (and SIP) culture that’s happening in our country.
* The reason is they are highlighting CAGR as if it’s something that’s guaranteed.
* A Mutual Fund’s CAGR and real return can be totally different.
* For instance, check out the returns of Axis Long Term Equity Fund – Regular Plan (G) — I have personally invested in this ELSS plan.

* So next time when you see that Mutual Fund ad that says “5 year – CAGR of 20%”, just tell yourself that its NAV was NOT moving up 20% every single year.

* Now I guess you know why CAGR is THE most important metric when it comes to investment returns comparison.

Video / Malayalam

I hope you have learned a thing or two from my new video. If so, do share my video with your friends and family on your social media channels!

Happy Investing/Trading! 🙂

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CAGR Calculator: My Favorite Financial Calculator

CAGR Calculator — My Favorite Financial Calculator

“Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.” – Albert Einstein

Today I’m sharing my favorite financial calculator with you – the “CAGR Calculator”. CAGR stands for Compounded Annual Growth Rate. Compounded Annual Growth Rate (or CAGR) shows how much a person’s investment grow in one year.

I started using a CAGR Calculator to track the performance of real estate and not stocks. Now I use it for anything and everything related to “Returns” like Stocks, Real Estate, Chit Funds, FDs, Insurance, Mutual Funds, etc. Previously, my favorite financial calculator used to be the Compound interest calculator. It demonstrated the Compound Interest’s magic.

CAGR Calculator

  • You invest in stocks for higher returns, right?
  • And stock markets are for long term, right?
  • But how do you measure your returns?
  • For example, 3 years back, you bought Tata Steel for 300 and today you sold it for 375.
  • That is, 25% returns in 3 years.
  • Optically it looks good. Because its Average Rate of Return = 25/3=8.33.
  • But I would say you earned below FD returns.
  • Because, if you invested Rs. 300 in FD @ 7.50% for 3 years then you would have the same amount of money. That is, Rs. 375.

  • That means, even after risking your money in the stock market… you haven’t even earned FD returns.
  • So the financial tool that I used to calculate the real return is called CAGR calculator.
  • CAGR stands for compounded annual growth rate.
  • CAGR shows how much a person’s investment grew in one year.
  • It is the average returns an investor has earned on the investments after one year.
  • Actually, I ended up using a CAGR Calculator to track the performance of real estate and not stocks.
  • Previously, my favorite financial calculator was Compound interest calculator.
  • That is, its purpose is to demo the Compound Interest’s magic.
  • So many tools are there for CAGR.
  • My favorite is from easycalculation.com.

  • So in Tata Steel’s case CAGR = 7.72%.

  • As you can see, CAGR considers timeframe.
  • 25% in 3 years is absolute return. And it’s the same even if it took 5 years or 10 years.
  • As mentioned, I started using CAGR Calculator for real estate and it immediately became my favorite financial tool.
  • Now I use it for anything and everything related to “Returns”.
  • Whether it’s Stocks, Real Estate, Chit Funds, FDs, Insurance, Mutual Funds, etc.
  • For e.g. You bought a land in 2000 for 10 lacs and sold it for 40 lacs today.

  • You can do the same calc for any asset class. Like Gold, Stocks, Insurance, etc.

Video / Malayalam

I hope you have learned a thing or two from my new video. If so, do share my video with your friends and family on your social media channels!

Happy Investing/Trading! 🙂

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9 hard-won lessons about money and investing by Matt Cutts

  1. You are probably a bad stock picker.
  2. No one cares about your money as much as you do.
  3. Wall Street is not your friend.
  4. Think about working for equity vs. salary.
  5. If you’re investing, prefer index funds.
  6. Prefer credit unions over banks.
  7. Prefer Vanguard over almost anyone else.
  8. You probably don’t need a “assets under management” financial advisor.
  9. Consider municipal bonds.

Matt Cutts is the head of the webspam team at Google.

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