Annualised Return is the average annual return on investment over a period of time where Compound Annual Growth Rate (CAGR) is an average growth rate over a period of several years.
You should know the difference between Annualised Returns and CAGR, which will help you to get the exact performance of any investment option. For e.g. An investment of five years, the 15% annualized return is actually 11.84% CAGR.
Let’s understand both one by one.
1. Annualised Returns: Annualised returns are calculated based on adding first year returns to the principal amount for calculation of next years returns and so on and so forth.
For example; You have invested Rs. 2,00,000 in one mutual fund scheme before 5 years which is now become Rs. 3,50,000. So at this point if you see the overall gain is Rs.1,50,000 which is 75% (this 75% is the absolute return on the principal amount invested) of invested amount. Here annualised return will be (75%÷5) 15% per year.
Formula to calculate Annualised Returns:
2. Compound Annual Growth Rate (CAGR): It is nothing, but the year on year growth rate over a period of time. It is also called “Net Yield”. CAGR gives you a better idea about the past performance of any investment.
For example: Investment amount of Rs. 2,00,000 for 5 years, the final investment value becomes Rs. 3,50,000. Here the CAGR will be approx 12% per annum ((Rs. 3,50,000/Rs. 2,00,000)^(1/5) -1).
Formula to calculate CAGR:
Lets us see how Annualise returns are different from CAGR.
The table above is showing an investment amount of Rs. 2,00,000 for five different years of performance. Even if for the entire five years the annualised returns are same i.e. 11.50%, but the CAGR is gradually reducing. So what did you get from this? The idea here is to tell you do not just enticed with any investment option showing very good returns, just to a recheck whether it annualized or CAGR.