POSTED BY December 23, 2010 6:43 pm COMMENTS (3)

ONWhat exactly is the utility of short-term / long-term 1-year/2-year/5-year performances?

“This fund has given a CAGR of 25% over the last 5 years”.

This means that if you had put x amount of money in that fund EXACTLY 5 years ago (not a day more not a day less), did not add anything, did not withdraw anything from the fund, then today the value of your money has increased to 3.05x (25% CAGR).

But is this practical?

Then there is the caveat “Past performances do not indicate future returns”. So that 25% is not very important. Right.

Then we try to be a fund collector too!! Diversify into multiple funds!

Very confusing. Yours comments please.

my take is slightly different. from long term and short term(i don’t mean short term as week or month, but quarterly, half yearly, and yearly ), one can have the idea of the consistancy of the performance. some new upcoming funds could be recognised by their short term performance v/s their long timer compitetors. i think, more important is consistency in performance over a period of time, but the short term performance could give hint for that.

Ramesh

Its a good question ,. you should see CAGR as a number which shows you the performance of the fund . so what you said is right for one time investment , but if you had invested through SIP where you put money every month and from 1,000 investment per month has become 15,000 after an year , then what is the return you have got ?

So lets say its X% CAGR , which means that every investment which you have made , if you calculate the X% return on that , it will add up to 15k , So

1000 invested in 1st motnh gives 15% return for 12 months it becomes X1

1000 invested in 2st motnh gives 15% return for 11 months it becomes X2

1000 invested in 3st motnh gives 15% return for 10 months it becomes X3

….

1000 invested in 11st motnh gives 15% return for 1 months it becomes X11

Now if you add this X1 , X2 .. X11 , it would become 15k , that is what is means that the fund gave X% CAGR , Now in reality each of your installment might have given different return , but we are trying to find that average X% , which is constant and satisfies the equiation .

So CAGR is a tool which you can measure the performance for 2 strategies of investment .

If Ajay invests 1000 per month for 1 yrs and then leaves it for 3 yrs , and at the end of 4th year it becomes 1 lacs .

And Manish invests 1 lacs per month for 23 months and then leaves his money in FD for next 15 months and at the end of the 4th year it becomes 27 lacs .

Despite of the numbers being different and quantum of money is differnet, how has made a superior invesment ? How was more smarteer and was able to grow their respective money ?

This answer can be given by only one thing which is CAGR , which tells the return they “actually” generated on their investments ! . I hope its clear now !

——

Regarding your comment

Then there is the caveat “Past performances do not indicate future returns”. So that 25% is not very important. Right.

Its very simple ,suppose there is a class of 50 students and you have to choose 2 people whom you want to involve in your project, now there will be some top performers who have some great track record in the past . Its very sure that they might not be the best people you can choose, may be some average person who have future potential should be choosen , but these top people cant be ignored, in most of the cases by all probability those 2 people you choose will be among these top performers only as they really have some thing in them which made them consistent performers from long.

In the same way if there are 10 funds which have been in top from many years and have given best returns, you will see some new funds next year , but most of these funds will repeat again ! .

So its all about giving more preference to these funds more than others , but with an open mind !

Manish

Hi Ramesh,

You should not look at CAGR only when investing. Look at other factors viz. Expense ratio, Portfolio churning, sector exposure etc. before investing.

Regards

Atul