## What is Compound Interest?

Compound interest, in simple terms, is interest on interest, meaning the addition of the interest amount to the original principal amount. It is calculated by the below formula:

Compound Interest = (P(1+i)^n) - P

Where,

P = Principal amount

I = annual interest rate

N = number of compounding periods

Let’s understand the above formula with the help of an example:

Suppose the investor has invested Rs. 10,000 at the rate of 10% interest per annum and compounding annually for 4 years. By using the above formula, here’s how the calculation would be made to calculate the compound interest:

Interest = (10,000(1+.10)^4) - 10,000

= Rs. 4,641

Hence, after 4 years, the investor’s corpus will be at Rs. 14,641. This includes both principal and interest.

## How to Compound the Rate of Interest (CAGR)?

Compounded annual growth rate, or CAGR, is the rate of return that would be required for an investment to grow from the initial value invested to the maturity balance. However, it is assumed that the gains are reinvested at the end of each investment period.

The Compound Annual Growth Rate can be calculated by using the below formula:

CAGR = [(Ending value/Beginning Value)^(1/N)]-1

We will understand the below with the help of an example:

Suppose the beginning value of the investment is Rs 10,000 and the ending value of the investment is Rs. 14,000 over a period of 2 years, CAGR would be calculated as below:

CAGR = [(14,000/10,000)^(1/2)] -1

= 18.32%

## What is a CAGR Calculator?

A CAGR calculator is an easy tool to analyze the returns.

You have invested in mutual fund and the value has increased over time, you can use the calculator and calculate the rate of return on your investment

The CAGR calculator provides you the annual growth rate that can be used to compare with a benchmark return prevailing in the market

## How to use Scripbox's CAGR calculator?

Scripbox's CAGR calculator is an online tool that can help you analyze your investment decision and helps calculate Compound Annual Growth Rate depending on the data entered by the user.

Investors can follow the below steps for using Scripbox CAGR calculator:

Step 1: Select the type of rate of return from the dropdown

Step 2: Enter the initial value of the investment

Step 3: Enter the final value of the investment

Step 4: Enter the number of years of investment

Click on submit after entering the above information, the CAGR calculator will automatically show you the CAGR on the basis of the data entered by you.

We will understand the below with the help of an example:

Suppose the beginning value of the investment is Rs 10,000 and the ending value of the investment is Rs. 14,000 over a period of 2 years, CAGR would be calculated as below:

CAGR = [(14,000/10,000)^(1/2)] -1

= 18.32%

To take another example, the beginning value of the investment is Rs 15,000 and the ending value of the investment is Rs. 20,000 over a period of 3 years, CAGR would be calculated as below:

CAGR = [(20,000/15,000)^(1/3)] -1

= 10.06%

## Benefits of using a CAGR calculator

Scripbox’s CAGR calculator helps an investor to calculate CAGR on their investments which in turn will help them in analyzing their investment decisions.

Below are a few other benefits of using a CAGR calculator.

- It helps the investors to evaluate the returns in various scenarios. Investors can use several test cases to evaluate returns in different scenarios. Since the calculator works on the data entered by the user, there is no possibility of the outcome being incorrect.
- It is simple and easy to use. The investors only need to enter the beginning value, ending value and the desired period of investment and the online calculator will do the rest.
- In practical scenarios, suppose the investor had purchased some units of an equity fund at some point in time whose value has increased now. With the help of the CAGR online calculator, the investors can find out the rate of return on the investment.

## How to calculate the CAGR - CAGR formula?

Compounded annual growth rate, or CAGR, in simple terms, is the rate of return that would be required for an investment to grow from the initial value invested to the maturity balance. However, it is assumed that the gains are reinvested at the end of each investment period.

The CAGR can be calculated by using the below formula:

**CAGR = [(Ending value/Beginning Value)^(1/N)]-1**

We will understand the below with the help of an example:

Suppose the beginning value of the investment is Rs 10,000 and the ending value of the investment is Rs. 14,000 over a period of 2 years, CAGR would be calculated as below:

CAGR = [(14,000/10,000)^(1/2)] -1

= 18.32%

## How to compare investments using CAGR?

CAGR is a more accurate way of calculating and determining returns of an investment the value of which changes over time. Investors can compare the 2 investment options of the same category or a market index using CAGR. How one investment is performing compared to the other of the same category and same time period?

But CAGR does not account for the risk factor. Since it is not risk-adjusted, it does not reflect the complete story of an investment. CAGR can prove to be a useful tool to compare 2 alternatives but not considering the risk associated with both alternatives

It is advised to use the CAGR approach wisely and to account for the risk adjustment before taking any investment decisions.

## Limitations of CAGR

Investment decisions taken on the basis of CAGR can go wrong if the investors do not have proper knowledge about its limitations. Below are some of the limitations of using CAGR:

- CAGR works on the beginning, ending value, and the number of investments. The formula assumes that there will be no change in the growth during the period of time and hence ignores volatility.
- CAGR cannot be used in the case of SIP mode of investments as the formula considers only the beginning value for calculation purposes. Hence it is used for lump-sum payments only.
- CAGR is not a stand-alone metric on the basis of which investment decisions are to be made. For example, in the case of equity investments, the Sharpe ratio is considered a better metric as it also takes the impact of risk-adjusted returns.
- CAGR assumes that the rate of interest will not change in the future which will obviously not be the case.

## Comparison of CAGR with Simple Interest

Particulars |
Simple Interest |
CAGR |

Meaning |
Compounded annual growth rate, or CAGR, in simple terms, is the rate of return that would be required for an investment to grow from the initial value invested to the maturity balance. | It is the sum that is paid by the borrower of money who has taken the loan for a specified period. |

Levy |
It is levied only on the principal amount | It is levied on both principal and interest amount |

Formula used |
Simple interest: Principal*Interest*No. of periods | Compound interest: [(Ending value/Beginning Value)^(1/N)]-1 |

Growth |
Growth is steady as the interest is levied on the principal amount | Growth is at an increased pace since interest is levied on both principal & interest. |