Question 1

Why is CAGR a better performance metric than Average Annual Return?

Accepted Answer

Average annual return can be misleading. If an investment goes up 50% in Year 1 and down 50% in Year 2, the 'average' return is 0%, but you have actually lost 25% of your money. CAGR (Compound Annual Growth Rate) provides a 'smoothed' annual return that accounts for volatility and tells you the true rate at which your investment grew from start to finish. It is the gold standard for comparing the performance of different asset classes over long periods.

Question 2

How do I use CAGR to compare a Mutual Fund with a Real Estate investment?

Accepted Answer

CAGR is perfect for 'apples-to-apples' comparisons. For a Mutual Fund, use the entry and exit NAVs and the duration. For Real Estate, calculate the total purchase price (including registration/taxes) and the final sale price (after brokerage/taxes). Duration is the years you held the property. By converting both to a CAGR percentage, you can clearly see which asset actually provided a better return on your capital, regardless of the different timeframes or investment sizes.

Question 3

What are the limitations of CAGR when analyzing an investment portfolio?

Accepted Answer

CAGR assumes the growth was steady and uniform every year, which is never the case in real markets. It hides the intermediate volatility (risk). Two funds could have an identical 12% CAGR over 5 years, but one might have been steady while the other had a 40% crash in between. Therefore, while CAGR tells you the 'what' (the final return), you should also look at metrics like Standard Deviation or Sharpe Ratio to understand the 'how' (the risk taken).

Question 4

Is it possible to have a negative CAGR?

Accepted Answer

Yes. If your final investment value is lower than your initial investment, your CAGR will be negative. This indicates that your investment lost value over the period. A -5% CAGR means you lost 5% of your remaining capital every year on average. It is a stark reminder to periodically review underperforming assets and cut losses if the long-term growth story has changed.

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