Absolute return measures the total gain or loss of an investment over a specific period. In contrast, CAGR shows the average annual growth rate, offering a smoother view of performance over time.
Compounded Annual Growth Rate(CAGR) is a widely used return metric because it truly captures the year-on-year return earned by an investment, unlike absolute return that captures the point-to-point return from an investment without considering the time taken to earn it.
Absolute Return can be valuable for comparing the performance of different investments over various periods. It helps investors see how much value has changed. On the other side, an annualized Return is particularly useful for forecasting future returns.
For irregular investments with detailed cash flow data, XIRR is often more useful and accurate than CAGR since it accounts for the timing and size of all cash inflows and outflows. However, for regular investments focused on long-term growth, CAGR may be sufficient and easier to calculate.
Absolute return is just the total gain or loss, like a basic percentage. XIRR is more precise for investments like mutual funds where you add money over time. It considers when you invested each amount, giving a more accurate picture of your overall return.
Absolute Return Funds are strategies that do not follow a benchmark - or market index - and are designed to generate positive returns regardless of market performance, managing risk while containing volatility.
While quite a few personal finance pundits have suggested that a stock investor can expect a 12% annual return, when you incorporate the impact of volatility and inflation, 7% is a more accurate historical estimate for an aggressive investor (someone primarily invested in stocks), and 5% would be more appropriate for ...
Actual number may be derived by subtracting the previous year population from the current year. For e.g. last year population was 100 and this year it is 150 so the absolute number of growth is 50. Annual growth rate is the overall percentage of population growing in a particular year.
Disadvantage of CAGR: Smoothing and Risk
One disadvantage of the Compound Annual Growth Rate is that it assumes growth to be constant throughout the investment's time horizon. This smoothing mechanism may yield results that differ from the actual situation with a highly volatile investment.
This metric is particularly useful for short-term investors who want to know how much their money has grown, regardless of market conditions. For example, if a mutual fund grows from Rs. 1,00,000 to Rs. 1,20,000, the absolute return would be 20%, offering a clear picture of the fund's success over that period.
What Is a Good CAGR? For companies with large capitalization, a CAGR in sales of 5% to 12% is good. For small-cap and midcap companies, a CAGR of 15% to 30% is good. Startup companies, on the other hand, should have a CAGR ranging from 100% to 500%.
To convert absolute returns to CAGR, one should take the nth root of (Current value of the investment/ Actual investment) and subtract 1 from it. In other words, ((Current value of the investment/ Actual investment)^(1/n)) – 1 will give the CAGR value.
For a developed economy, an annual GDP growth rate of 2%-3% is considered normal. Therefore, any GDP growth above the said rate is a strong sign that an economy is expanding and prospering. A prospering economy creates more wealth, which leads to increased spending.
Internal Rate of Return (IRR)
IRR is useful when cash is added or withdrawn at different times, like in real estate or project financing. Unlike CAGR, it takes into account uneven cash flows and the timing of when money comes in and goes out. IRR usually requires software like Excel to calculate.
The company is often compared to an investment fund; between 1965, when Buffett gained control of the company, and 2023, the company's shareholder returns amounted to a compound annual growth rate (CAGR) of 19.8% compared to a 10.2% CAGR for the S&P 500.
$3,000 X 12 months = $36,000 per year. $36,000 / 6% dividend yield = $600,000. On the other hand, if you're more risk-averse and prefer a portfolio yielding 2%, you'd need to invest $1.8 million to reach the $3,000 per month target: $3,000 X 12 months = $36,000 per year.
What Is the Rule of 72? The Rule of 72 is an easy way to calculate how long an investment will take to double in value given a fixed annual rate of interest. Dividing 72 by the annual rate of return gives investors an estimate of how many years it will take for the initial investment to duplicate.
In a nutshell, absolute return seeks to make money during a specific period of time, regardless of market conditions. Admittedly, it is easier said than done.
Saving for retirement should be an important goal even during a crisis or recession. If you have a retirement plan or individual retirement account, you may want to continue to invest so you can take advantage of the income tax benefits and your employer's match, if you receive one.
The adjective "absolute" is used to stress the distinction with the relative return measures (often used by long-only stock funds) that are based on comparison to a benchmark. The hedge fund business is defined by absolute returns.
Which is better, XIRR vs CAGR? It depends on the type of investment. For investments with regular cash flows, such as lump sum investments, CAGR is a good enough measure of returns. However, for investments with irregular cash flows, such as SIPs, XIRR is a better measure of returns.
Absolute returns Calculates the total percentage increase or decrease in your investment. CAGR:Shows the annual growth rate of your investment over a specific period of more than a year, assuming that your gains are reinvested at the end of each year.