Your money has doubled, but it's not 100% returns!
A friend of mine, Geeta, and I were discussing real estate purchase from an investment perspective. Now, if you’ve read any of my articles, you’d know where this discussion/argument would have gone, but that’s not the point of discussion of this article. Today, I’m going to speak about how to actually calculate your return on any investment, and then decide whether it’s worth it or not.
[In case you haven’t read my post on real estate investment, you can read it here]
Anyway, Geeta was very excited about the ROI on her property purchase. She said she had purchased a home in 2015 for Rs. 1 crore, and now in 2021, it was valued at Rs. 1.5 crore.
Now, her evident argument is “Ankur, I’ve got a 50% return on my investment! How can you say Real Estate doesn’t give good returns?”
And my question to her was “You’ve got a 50% return in 6 years. Did you calculate what was the ANNUAL return, or the CAGR?”
Geeta: “CAGR? What’s that?”
Ankur: “Aah, so you don’t know what CAGR is? How do you calculate your returns then?”
Geeta: “Simple. Return on Investment = (Final Value - Initial Value)/Initial Value *100”
Ankur": “That’s the problem with calculating returns. You’ve got 50% returns in 6 years. This is called Absolute Return. Which is your return on investment over a period of time (here, 6 years). What you need to calculate, is the Annual Return, or the CAGR (Compounded Annual Growth Rate), which will tell you how much is the annual return of your investment. This means if your 1 crore has grown to 1.5 crores in 6 years, the absolute return is 50%. But the CAGR is only 6.99%. Which means, every year, your investment grows at the rate of 6.99%.”
Geeta: “Oh! So 6.99% CAGR is not good?”
Ankur: “Well Geeta, inflation sometimes crosses 7% in India.”
Geeta: “What?! So you’re saying that if inflation is 7.2% in any year, I am actually losing money?”
Ankur: “Unfortunately, that’s exactly what I’m saying.”
And Geeta went home with a sad face.
Well, this story was fictional. But the fact about returns is 100% true. When you’re evaluating ANY investment, don’t ever look at Absolute Returns, because you can’t compare two investment products over different periods of time. You need to compare or evaluate it using annual returns. And the best indicator for this is the CAGR.
Whether you’re investing in Stocks, Mutual Funds, FDs or even real estate. Look at CAGR or Annual Returns. There are plenty of websites that have CAGR calculators, where you just need to key in the initial value, final value and the number of years, and the website will give you the CAGR %. Here’s a simple Google search for CAGR calculators. You can use any of these to evaluate your investment returns.
Well, that’s all about today’s post on calculating returns. Hope you’ll be more prudent in making investments (unlike my fictional friend Geeta).
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