How you measure yourcan make a significant difference in terms of how you assess an . For investors towards a goal, this is even more important. The that a goal demands, can decide whether you need to more or less to reach that goal.
Your return, their return
What do you look for after you have figured out the financial goal and the asset class it will need (We hope you do that first!)?
The most likely answer isover multiple periods, and especially over extended periods.
However, many investors don’t see the same rate of return as the ones found on even the websites of , much less in star ratings rankings that seem to change every year.
Investors are often puzzled by this. It’s much beyond “Past performance is not an indicator of future performance”. It’s more about the how and what.
The CAGR perspective
is one of the most popular ways in which returns from various asset classes is measured. Let’s consider the formula:
(Value of anat the end of the measurement period/ Value of an at the beginning of the measurement period)1/total period in years – 1
What this will tell you, based on the values you put in, is the returns from anfrom one period to another.
Let’s take the example of yourin an FD. You invested Rs 1 Lakh on 3rd Jan 2015. On 3rd January 2019 you decided to close the FD as you needed the money for a short vacation. Let’s assume you got Rs 1.20 Lakh after tax.
On the surface it looks as if there was a 20% gain since the money grew by Rs 20,000. But we should not forget that this happened over a period of 4 years. Thein this case using the formula shown, gives us 4.66%. So, your money grew by 4.66% each year.
This was calculated like this: (120,000/100000)^¼-1 = 4.66%
Similarly, when ansays it has delivered a of 16% since inception. This means that the grew by 16% annualised from its year of inception, say 1st January 2000 till 1st January 2019. For example, if you invested Rs 50,000 in 2000, it would have become Rs 8.4 Lakh by 2019.
But would your money have grown at the same pace had you invested in ain the same ? Chances are not. Here’s why.
When you invest via SIP or even if you make periodic investments in a lump sum manner, each one of your investments grows at its own growth rate. Why? Simply because each investment has a different period that it has grown for.
Each SIP instalment is a separate investment
When youvia or even if you make periodic in a lump sum manner, each one of your grows at its own . Why? Simply because each has a different period that it has grown for.
Let’s consider aof Rs 5000 started in January 2012. Till date (Jul 2019), you would have made a sum total of 91 instalments. While the might have delivered 16% annualised between 2012 and 2019, you might have the same or a different .
Theinstalment made in Jan 2012 would have grown the longest whereas the one made in July would have grown for the shortest period. Each instalment would have a separate simply because the period for each would be different. This means that to arrive at a true picture of your growth you need to take into account the growth of each instalment.
Does this mean you’d have to do 91 CAGR calculations and aggregate them?
In a way yes, but there is a simpler way called XIRR. Using this approach, which is somewhat complex to do on paper, the modified is calculated for a set of across different periods. It is normally done using an application such as Microsoft Excel or Open Office Calc. XIRR in mathematical terms is nothing but the “weighted average” of multiple CAGRs. The approach also involves “guessing” the return for each to arrive at the actual for the whole .
Because of this you would arrive at a final return number that could be different than what the NAV value of the units you bought at the point. From the fund’s perspective, only the beginning value of the and the current value of the matters. But from your perspective, each of your instalment’s growth matters.shows. It could be higher or lower depending on the
However, a consistentpattern over a long enough duration normally gives you a value which is more or less the same as the shown by the . This will rarely mean that you earn exactly the return mentioned by the . Therefore, take that only as indicative rather than an absolute certainty.
In the end, the only thing that matters is if you are on track towards your goal and is the overall enough to achieve this.