Investor Corner/Building and judging a portfolio/Performance Measurement
3.2.1 CAGR
CAGR, or Compound Annual Growth Rate, is the smoothed annual return that would take an investment from its starting value to its ending value over a multi-year period, ignoring how bumpy the actual path was.
A smoothed, hindsight figure
If ₹1 lakh grows to ₹2 lakh over six years, the CAGR is the single steady annual rate that would produce that same doubling, close to 12% in this case. The actual year-by-year path almost certainly did not move at a constant 12%; some years likely rose more, others less, and some may have fallen. CAGR flattens all of that into one convenient, comparable number.
CAGR (Compound Annual Growth Rate) is the annualised rate of return that smooths out the path between a starting value and an ending value over a specified period. It answers the question: at what steady annual rate would the investment have grown from the starting value to the ending value? For a lump-sum investment, CAGR captures the complete return picture. If ₹1 lakh grew to ₹3.1 lakh in 10 years, the CAGR is approximately 12%: the constant annual rate that explains the entire growth.
The formula is: CAGR = (Ending Value / Beginning Value)^(1/n) - 1, where n is the number of years. It strips away the year-by-year volatility and presents a single, clean number that makes comparison across investments and time periods straightforward. A fund that returned 25% one year and -5% the next can be compared on CAGR terms with one that returned 12% and 8% over the same two years.
Why it works well for lump sums, and poorly for SIPs
CAGR is a fair and appropriate measure when a single lump sum was invested at one point in time and held to a specific end date. It becomes misleading for a SIP or any series of contributions made at different times, since it cannot properly account for money that entered the investment at different points along the way. XIRR exists specifically to handle that more complex situation correctly.
CAGR is the right measure for a single lump-sum investment with no additional deposits or withdrawals. It is not the right measure for SIPs or portfolios with multiple cash flows at different times, because it ignores the timing of those flows. For SIP investments, XIRR is the correct measure. Using CAGR on a SIP by treating the total invested amount as the starting value and the current value as the ending value will produce a misleading result because it does not account for the fact that different instalments had different time periods to compound.
Reading a quoted CAGR carefully
A fund's advertised CAGR depends heavily on which start and end dates were chosen for the calculation, and providers can sometimes select a favourable window without being technically dishonest about it. Checking CAGR over several different periods, rather than trusting a single quoted figure, gives a far more reliable picture of consistency.
How PriLytics helps. For a single lump sum, PriLytics shows the actual value trajectory over time; for anything involving multiple contributions, it computes proper XIRR instead of a misleading CAGR. See how returns are calculated.
When evaluating fund performance, CAGR should be compared over matching time periods and against the appropriate benchmark's CAGR over the same period. A fund's 5-year CAGR of 14% means little in isolation; it only becomes informative when compared against the Nifty 50 TRI's 5-year CAGR of, say, 12% and the category average of 13%. Context is everything. A 14% CAGR in a raging bull market may represent underperformance, while 14% in a difficult market may be exceptional.