Understanding CAGR, Absolute Returns and XIRR
It's important to use a combination of these metrics and other fundamental analysis to make informed investment decisions
CAGR, Absolute Returns and XIRR are commonly used financial terms in the Indian investment landscape and understanding them is crucial for any investor to evaluate the performance of their investment portfolio.
CAGR or Compound Annual Growth Rate, is a measure of the annual growth rate of an investment over a specified period. It calculates the average rate at which an investment grows annually, considering the effect of compounding. CAGR is calculated using the formula [(Ending Value/Beginning Value)^(1/Number of Years)] - 1. CAGR is an important metric for evaluating long-term investments as it takes into account the impact of compounding, which can significantly boost returns over time.
Absolute Returns, on the other hand, are the total returns earned on an investment over a specified period, without taking into account the time value of money or the impact of compounding. Absolute returns are simply the difference between the ending value and the beginning value of an investment, expressed as a percentage of the beginning value.
XIRR or Extended Internal Rate of Return, is a more comprehensive measure of the returns earned on an investment, taking into account the time value of money, cash inflows and outflows. XIRR calculates the discount rate at which the net present value of all cash flows associated with an investment equals zero. XIRR is especially useful for evaluating investments that involve multiple cash inflows and outflows, such as mutual funds, as it considers the timing of each cash flow.
In India, CAGR, Absolute Returns and XIRR are commonly used to evaluate the performance of mutual funds, stocks and other investment instruments. Investors should keep in mind that while CAGR and XIRR are useful for evaluating long-term investments, Absolute Returns can provide a more accurate picture of short-term performance. It's important to use a combination of these metrics and other fundamental analysis to make informed investment decisions.