The quickest way to double your money is to fold it in half and put it in your back pocket
– Will Rogers
Have you ever wondered about the evaluation of your investments? Or have you never bothered about how much and where you have invested? Do you know about the nuts and bolts of how to evaluate your investment? Do you know that your money should grow at a compounding rate instead of gathering dust in an unyielding investment plan?
These are some of the primary aspects that many people ignore while investing.
Also even the more unfortunate part is that they never know that they don’t know! Of course, most of us invest with the anticipation of end-result in mind, but there are times when this result, instead of multiplying the principal amount rather shrinks it to a bare minimum, thereby draining out years of hard-earned money. The biggest mistake they make is they ignore the conditions-apply part that ‘all investments are subject to market risks’. Hence, keep failing to keep track if their money is growing or rusting away.
So, how to find out if your money is growing at a compounding effect?
It is slightly technical to understand how it works. I am not getting into that because I aim to make this very simplified so that you know precisely what numbers to look at and when to take notice!
CAGR (Compound Annual Growth Rate)
To understand CAGR, you need to have three inputs; the beginning amount, the end amount of maturity and the time period. It may appear that CAGR is superior to average returns. This can be due to the assumption that all returns get compounded, to make it a smoothened return.
Consider the following investment:
In the above case, the CAGR is 21.7% XIRR (Extended Rate of Return)
XIRR is also a rate of return but is more flexible since it considers multiple cash flows and periods. While CAGR uses the beginning and ending value, in reality, cash inflows and outflows occur when it comes to investments.
Consider the following investment:
In the above case, using the Excel function “XIRR,” we obtain 36.4%.
Difference between CAGR and XIRR
CAGR can be a simple calculation if you have understood here. But if you have varied amounts invested over a period of time, then the XIRR method needs to be taken up. CAGR works most accurately when you make a one-time investment, and the maturity amount keeps getting re-invested. However, what happens when you invest in mutual funds through a Systematic Investment Plan (SIP)? The earning percentage for each tenure could be different, and that is where the CAGR fails to provide accurate earnings percentage over the cumulative investment tenures.
The XIRR accounts for the multiple investments made in the same SIP over the investment tenure. It treats them as separate investments.
CAGR may help you to understand your investment return over some time. This can help you to understand the overall return on your money if there are consistent investments. On the other hand, if you have multiple amounts invested, then XIRR is a better tool.
Ramesh, a client of mine, came to me and declared that he was getting good returns from real estate. I asked him about the numbers. He, with a cheek-to-cheek smile on his face, said that he was getting around four times what he invested ten years back. I calculated on my financial calculator. It was just 14.86% return pre-tax and only a gross return.
I told him that some equity mutual funds could have fetched the same return. Besides, there were least taxes and worries involved. Investment in mutual funds could have been more straightforward and transparent.
Ramesh looked at me as if struck by lightning. He was amazed to know the background of such a calculation called CAGR. ftis could have saved him from a plethora of hassles that are likely to surface in the case of real estate. fte odds are that most people don’t know about this simple evaluation for anyone seeking richness. You should know as to how much your money should work on an absolute minimum return. You should then know how to check it and when to check it. ftat’s a goal, that must be journalized on a regular basis.
If you don’t know what you are looking for, then you are set on a journey without a destination.
One day Sandesh came to my office, and he was literally in tears. He said that he had been earning Rupees two lakh per month and was living a lavish life. But the mistake he made was, he invested all his money in one or two investment plans. And an even bigger mistake he made was he never monitored if his money was growing. One day, his close friend called him, asking for some money since his friend’s mother was seriously ill. Sandesh thought of taking out some money from his investments but to his surprise, a significant part of the money had been drained away. His years of investment almost kissed the rubble. Ultimately, he was not able to help his friend since he did not have even that much money in his account. Why? Because he missed on the big G; the GOAL of what he wanted and how to monitor.
There are only 3% of people I have come across who set goals on their investments. That could be the reason for not becoming rich! Not wishes but Goals. You must be specific. Learn how you can get it right. Write down your goals and make your money work accordingly. For detailed information on goal-setting, you may refer to the earlier Chapter 12.
Here are some tips:
- If you have invested a lump sum amount for a certain number of years, there are parameters to find out the effective year to year This comes out clear from the CAGR method of returns.
- Then, you may compare it with other alternative investments that had the same risk and the same tax
- If you have invested regularly every month, then after x number of years, you can find out the year to year return on your investment. This is called an XIRR method of
- Year to year return on an investment that you made needs to be seen once in a period of 2-3-year. You don’t have to look at it every month.
- But if you have invested in an equity mutual fund and its CAGR from the time you invested, till today, doesn’t have a good CAGR (good means better than the benchmark return of that category of that type of fund), then you need to Talking to your planner will help you to understand as to why it is still being continued in your portfolio. Does it require some evaluation? Does your planner have enough reasons to keep pursuing?
Download Excel Here: http://therichnessprinciples.com/download
- It’s like driving in the dark without you knowing if you are on the right course of action
Know that you understand how to evaluate your returns technically and continuously. Once you have learned the traits, you become powerful enough to keep checking your investments and make them grow.So, go and become rich!Make your money work harder and faster.
Taressh Bhatia is a CFPCM CERTIFIED FINANCIAL PLANNER CM and is the founder/partner of Advantage Financial Planner LLP – A firm Registered with SEBI (Securities and Exchange Board of India) as RIA (Registered Investment Advisor).
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