What is the Difference Between Absolute Return and CAGR?

What is Absolute Return?

Absolute return is the actual return that an investor earns over a period of time irrespective of the gains or loss on an investment portfolio. But it is expressed in the percentage form. Before understanding absolute return vs CAGR , it's important to know what absolute return and CAGR is.

Absolute return is independent of the market conditions. It is also known as total returns. There is no need to consider the time factor while calculating absolute return in mutual funds. Absolute return in a mutual fund means the return on profit or loss on an investment. In terms of mutual funds they are point to point returns.

After investing in the stock market it becomes important to analyse the portfolio to understand how the stocks are performing according to the stock market. Absolute return is the direct way to analyse the profit and loss on a stock after a specific time.

Absolute Return Formula

Absolute return calculation is done with the help of the given formula :

Absolute returns = [(Current Value / Initial Investment Value) - 1] * 100

For example : Prateek invests Rs 1,00,000 and after a time the amount increases to Rs 1,50,000.

Now for the absolute return calculation use the above formula :

• Absolute return = [(1,50,000/1,00,000) - 1] * 100
  
• Therefore , Absolute return = 50%

Importance of Absolute Returns

The absolute return is important because of the following reasons :

Diversified Portfolio : When an investor invests in the stocks for a long period of time then it becomes necessary for the investor to have diversification in the portfolio. And absolute returns help the investor in portfolio diversification. Absolute returns show the risk and help the investor in reducing the risk. There are different assets where an investor can diversify the investments.

Simple Calculation : The calculation is simple when it comes to the absolute returns. The things which an investor needs to take care of is the initial investment value and the final value to quickly assess the absolute returns.

Good Returns : At the end every investor wants to make profit out of the investments. Absolute returns help in assessing the stocks without considering the market conditions. The goal is clear to get good returns over a period of time to make the investment portfolio stronger.

Independent of Market Conditions :  Very rarely the absolute returns are affected by the market conditions. But the relative returns are more volatile as compared to the absolute returns. Therefore helping the investors to make better strategies about their investments.

Also, Check - What is Direct and Indirect Tax?

CAGR Meaning

CAGR full form is Compound Annual Growth. When the average rate of return is calculated annually for an investment over a specific period of time then it is known as compound annual growth.

It is related to different financial parameters. With the help of the financial parameters it becomes easy to evaluate the performance of the company over a period of time. To assess the profitability of a business it's important to calculate its CAGR.

CAGR helps in understanding the annual growth rate. Because of which the investors get a clear idea about the stock market. Eventually helps the investors to make good financial plans.

e.g. Tata Motors Ltd has delivered good profit growth of 93.1% CAGR  over  the last 5 years. 

How To Calculate Compound Annual Growth Rate?

The formula to calculate CAGR is :

• CAGR = (EV/BV)^1/n-1
• EV : End Value
  
• BV : Beginning Value
• n : Investment period

Steps To Calculate Compound Annual Growth

1. Firstly divide the ending value with the investment value at the beginning.
2. Now  calculate the power where the number of years will add and subtract 1 from it.

In this way CAGR calculation is done.

CAGR Example : Let's say Rahul invests in a stock of Rs. 1,00,000 for 6 years. And it becomes 3 lakhs after the investment.

• Hence , CAGR = (3,00,000/1,00,000)^⅙ - 1
  
• CAGR = 20%
  

CAGR VS Absolute Return

The difference between CAGR and absolute return is as follows :

SNo.                      CAGR                                                              Absolute Return

1	CAGR stands for Compound Annual Growth.	Absolute return is the total return that an investor gets irrespective of  period of time.
2	The calculation of return is done annually.	The calculation of return is independent of the period of time.
3	Formula to calculate CAGR is  (Ending Value/Beginning Value)^1/n-1	Formula to calculate Absolute return is [(Current Value / Initial Investment Value) - 1] * 100
4	In terms of accuracy CAGR is better.	Here the accuracy is less as that of CAGR.
5	Normally comparison happens with benchmark/index.	Here no comparison is done with benchmark/index.

FAQ’s

Q1. What does 10% CAGR mean?

Ans. 10% CAGR means when the 10% is added to the principal investment on the interest every year.

Q2. What is the difference between growth rate and CAGR?

Ans. The only difference between growth rate and CAGR is that CAGR rate is compounded annually whereas the normal growth rate does not compound annually.

Q3. Why is CAGR better than absolute return?

Ans. CAGR is better than the absolute return because CAGR is more consistent as that of absolute return.