Friday, October 30, 2015

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CAGR – What is it and How to calculate it for your investments?

Everyone knows what the interest rate is for Bank FD’s, and PPF to name a few investment products. Bank FD offers around 9% and PPF offers 8.7%. Given the interest rate, I guess you know how to calculate the final maturity amount of an investment.
Maturity = ( (1 + R)^N ) * Investment
Where R = Annual rate of Interest and N = Number of Years till the Maturity

But, the investment cum insurance schemes offered by LIC do not advertise any interest rate that you can expect from their schemes. Because, obviously, it is not going to be fixed; rather dependent on the actual bonus rates declared by LIC every year.
As an investor, you must normalize expected returns offered by any investment scheme into a single number and compare it with other products. That number is called “CAGR”. CAGR is the Cumulative Annual Growth Rate of your investment. In fact, it is same as interest rate as said in Bank FDs. But, here, we ourselves have to calculate annual interest rate, from other parameters.
As an example, if you get 2250 back after 3 years with an initial investment of 1000, the CAGR can be calculated as follows. Note that this formula is derived from the above compound interest formula.
CAGR = ( (Maturity / Investment)^(1/N) – 1 ) * 100CAGR = ( (2250/1000)^(1/3) – 1 ) *100 = 31.04%
Before choosing a plan like LIC’s New Jeevan Anand, you may better calculate its expected CAGR and then decide. Of course, CAGR alone cannot be the single deciding factor; you should consider the risks associated with each investment product as well. But one thing is for sure; you cannot ignore CAGR!
Link for my last video on how to calculate returns of LIC’s New Jeevan Anand policy:https://youtu.be/15dgX1dSsDc
Stay tuned for such videos by clicking here: http://bit.ly/AnandSpeaking

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