Absolute Return vs Annual Return

When you invest your money, you want it to grow. But how do you measure the growth of your investment? There are two common metrics used to measure investment returns: absolute return vs annual return. While making your investment decisions, comprehending these two investment metrics properly becomes significant for achieving your financial goals. This article will discuss the differences between Absolute Return vs Annual Return, their significance, and how they can impact your investment strategy.

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What is Absolute Return?

Absolute return is the percentage of actual gain or loss an investment generates over a specific period with respect to the initial investment amount. This metric does not depend on the performance of the market or other benchmarks. This means that an absolute return investment can still generate positive returns even if the market is declining.

Formula for Absolute Return

Absolute Returns = ((Present NAV – Initial NAV)/ Initial NAV) ×  100

For Example: If you invest in ICICI Prudential BlueChip Fund

  • Lump sum investment in the fund= Rs. 5000

  • Period of investment= 5 years

  • The value of your investment becomes= Rs. 6000 (after 5 years)

  • Your Absolute Return= ((6000-5000)/5000) × 100

                                       = 20%

Reason: The value of your initial investment has grown by 20%, regardless of whether the market has gone up or down during this period.

Absolute return investments can be a good option for you if you are looking for a way to generate positive returns in all market conditions. However, it is important to note that investments made on the basis of absolute return can also be more volatile than traditional investments. 

What is Annual Return?

Annual return, also known as Annualized Return or Compound Annual Growth Rate (CAGR), is a measure used to calculate the average rate of return on an investment over a specific period, typically one year. It allows you to understand the average annual growth rate of your investment. 

It considers the starting value, ending value, and the time elapsed during the year. It is expressed as a percentage and represents the annualized growth or decline of the investment. 

CAGR provides a way to express the average yearly performance of an investment, taking into account compounding effects.

Formula to calculate the annualized returns

Annualized Return (CAGR)

= ((1 + Absolute Rate of Return) ^ (365/no. of days)) – 1

= ((1 + Absolute Rate of Return) ^ (1/no. of years)) – 1

= ((Present NAV/ Initial NAV) ^ (1/no. of years)) – 1

For Example, If you invest in ICICI Prudential BlueChip Fund

  • Lump sum investment in the fund (on 22 July 2023)= Rs. 1 lakh

  • Fund NAV (on 22 July 2023)= 20.04

  • No. of units purchased= 5000

  • Investment period= 5 years

If you redeem your fund on 22 July 2028:

  • Selling price of your fund value= Rs. 1.51 lakhs

  • Total profit= Rs. 1.51 lakhs – Rs. 1 lakh

                           = Rs. 51,000

CAGR = [(1,51,000/1,00,000)^⅕ ]– 1

Your Annual Return (CAGR)= 8.5%

NOTE: In the same way, you can calculate the annualized return for 3/ 6/ 7/ 10 years.

*Use the CAGR calculator to estimate your annualized return over a period.

Annualized return is particularly useful when comparing the performance of different investments. It is also useful to forecast future returns or to consider long-term investment strategies.

NOTE: It is important to remember that past performance is not necessarily indicative of future results. The CAGR metric also does not take into account fund volatility.

Absolute Return vs Annual Return

Let us understand the difference between absolute return and annual return from the table mentioned below:

Particulars Absolute return Annualized return
Definition The total percentage change in the value of an investment over a specific period, without taking into account the effect of compounding. The average rate of return per year over a specific period, taking into account the effect of compounding on the investment returns.
Calculation ((Present NAV – Initial NAV)/ Initial NAV) ×  100 ((Present NAV/ Initial NAV) ^ (1/no. of years)) – 1
Accuracy Typically less accurate than annualized return, as it does not factor in compounding. Typically more accurate than absolute return, as it factors in compounding.
Simplicity Simpler to understand than annualized return. More complex to understand than the absolute return.
Usefulness It can be used to compare the performance of different investments over different time periods. It can be used to forecast future returns.
Limitations Does not take into account the risk of an investment. It can be misleading if the investment period is short.

Illustration of Absolute Return vs Annual Return

Let us assume your initial investment in Fund A and Fund B is Rs. 10,000 each for a 5-year period.

Year Fund A Value Fund A Absolute Return (%) Fund A Annual Return (%) Fund B Value Fund B Absolute Return (%) Fund B Annual Return (%)
Year 1 Rs. 12,000 20% - Rs. 11,500 15% -
Year 2 Rs. 14,000 40% - Rs. 13,000 30% -
Year 3 Rs. 13,500 35% - Rs. 15,500 55% -
Year 4 Rs. 15,500 55% - Rs. 16,500 65% -
Year 5 - - CAGR= ((Rs. 16000/ Rs. 10000) ^ (1/5)) – 1 = 10.3% - - CAGR= ((Rs. 20000/ Rs. 10000) ^ (1/5)) – 1 = 14.8%

Analysis of Absolute Return vs Annual Return:

  • Therefore, Fund B has a higher Absolute Return and Annual Return (CAGR) compared to Fund A over the five-year period. 

  • The Annual Return (CAGR) provides a more standardized measure of investment performance, allowing for a fairer comparison between the two investment options

  • However, it is essential to consider other factors, like your risk appetite, fund charges, expense ratio, and investment objectives, before making your investment decision.

Which is Better Absolute Return vs Annual Return?

The choice of a better metric depends on what you're looking for. If you're concerned about the overall growth of your investment, then the absolute return is a good metric to use. But if you're interested in how your investment is performing compared to other investments, then the annual return is a better metric to use.

For Example:

Imagine that you are running a race. Your absolute return is how far you have run, regardless of how long it took you to run that distance. Your annual return is how fast you are running, measured over a one-year period.

So, which is more important? It depends on your goals. If you want to win the race, then you need to focus on your absolute return. But if you want to improve your running speed, then you need to focus on your annual return.

In the world of investing, it is important to use both absolute return and annual return to measure the performance of your investments. 

This will give you a complete picture of how your investments are performing and help you make better investment decisions.

Bottom Line

Absolute Return and Annual Return (CAGR) are both essential measures of investment performance. While Absolute Return reflects the exact financial outcome of an investment, Annual Return (CAGR) provides a standardized metric for comparing different investments, making it a more useful tool for assessing long-term performance.

Investors should consider both measures to gain a comprehensive understanding of an investment's performance, taking into account factors like risk tolerance and investment objectives before making informed decisions.

FAQ's

  • What is the full form of CAGR?

    The full form of CAGR is Compound Annual Growth Rate.
  • What is CAGR?

    CAGR stands for Compound Annual Growth Rate. It is a measure used to calculate the average annual growth rate of an investment over a specific period, considering the effects of compounding.
  • How do you calculate absolute return to Annualised return?

    The formula to calculate the Annualized Return (CAGR) from the Absolute Return is as follows:

    Annualized Return (CAGR) = [(1 + Absolute Return)^ (1 / Number of Years)] - 1

  • Which is better, CAGR or absolute return?

    Which measure is better depends on the context and your specific needs. If you want to compare and evaluate the long-term performance of various investments on an equal footing, CAGR is more appropriate.

    If you want to know the actual gains or losses of an investment over a specific time period, Absolute Return is more straightforward and informative.

  • What are absolute returns in mutual funds?

    Absolute Returns in mutual funds refer to the actual gain or loss generated by the fund over a specific period, expressed as a percentage of the initial investment. It represents the absolute performance of the mutual fund without any comparison to a benchmark or market index.
  • What is 5 year annualized return?

    A 5-year annualized return, also known as 5-year CAGR (Compound Annual Growth Rate), is the average annual growth rate of an investment over a 5-year period, considering the effects of compounding. It provides a standardized measure of performance that allows investors to assess the average yearly growth of their investment over a specific 5-year timeframe.
  • Is annualized return the same as CAGR?

    Yes, annualized return and CAGR (Compound Annual Growth Rate) refer to the same concept. Both terms represent the average annual growth rate of an investment over a specific period, considering the effects of compounding.
  • How do you calculate annualized returns?

    Use the below-mentioned formula to calculate your annualized returns from your investment funds:

    Annualized Return (CAGR) = [(Final Value / Initial Value)^(1 / Number of Years)] - 1

Past 5 Year annualised returns as on 01-06-2024

^The tax benefits under Section 80C allow a deduction of up to ₹1.5 lakhs from the taxable income per year and 10(10D) tax benefits are for investments made up to ₹2.5 Lakhs/ year for policies bought after 1 Feb 2021. Tax benefits and savings are subject to changes in tax laws.

*All savings are provided by the insurer as per the IRDAI approved insurance plan.

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^^The information relating to mutual funds presented in this article is for educational purpose only and is not meant for sale. Investment is subject to market risks and the risk is borne by the investor. Please consult your financial advisor before planning your investments.

#The lumpsum benefit is calculated if policyholder invested ₹10000 monthly for 10 years in the fund with a policy term of 20 years. This Point To Point past performance data of last 10 years has been used to illustrate a scenario for the customers benefit. It is assumed that the past 10 years returns would have also been delivered in last 20 years. This is not guaranteed and not in anyway indicative of what the customer may actually get 20 years from now. The investment is subject to market risk and the risk is borne by the policyholder.

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