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Investors use various indexes to assess the returns of different mutual funds and decide whether or not to invest in a particular fund. One such index is the total return index which presents the price movements and the dividend payout.
It is a key marker used by most investors and hence, in this article, we will look at the total return index, its calculation and its importance.
What is the total return index?
Looking at the past performance of a security is integral to assessing its future performance. With this idea, the total return index measures both, capital appreciation and dividend returns. It indicates the impact the dividend payouts have on the investments made by individuals.
This index works with the assumption that the dividends were reinvested. As a result, this index allows the potential investors to account for every part of the return and not solely the price movement.
It calculates all capital gains as well as cash distributions such as interests or dividends. As a result, the total return index provides a complete picture to the investors to assess the performance of the security.
You can observe the BSE total return index, NSE total return index, Sensex total return index, NIFTY 100 total return index and all ordinaries total return index.
How to calculate the total return index?
With an understanding of what is total return index, let us now look at how it is calculated. The formula for calculating the index is:
Total Return Index = Previous TR * [1+(Today’s PR Index +Indexed Dividend/Previous PR Index-1)]
The calculation of the index can be broken down into three main steps, these include:
- The first step is the division of the dividend paid by the index’s base cap. The usage of the base cap is to find the index points. This calculator gives the dividend payment value per index point. This calculation can be portrayed as:
Indexed dividend (Dt) = Dividend Paid out / Base Cap Index
- The second step entails adjustment of the price return index for a specific day. Add the price change index and the dividend to get the value. The calculation can be portrayed as:
(Today’s PR Index +Indexed Dividend)/Previous PR Index
- Lastly, apply the modifications of the price index to the total return index. Not multiply the result with the total return index of the previous day. This calculation can be portrayed as:
Total Return Index = Previous TRI * [1+ {(Today’s PR Index +Indexed Dividend)/Previous PR Index}-1]
You can further also segregate the total return index into the net total return index and gross total return index to evaluate tax credit separately.
Why is the total return index important?
The total return index is important in various ways. Some of the key reasons for which it proves beneficial include:
- Accurate measurement
This index provides a more detailed view of security. While the retail investors focus solely on the price movements the total return index also accounts for the impact of dividend and interest income.
- Comparison
Investors often utilise the total return index to compare the returns of their mutual funds to those managed by professional fund managers. As a result, TRI helps assess the success of various instruments.
- Long term perspective
The total return index helps investors in building a long-term strategy for the management of their securities. As compared with other indexes such as the price return index, it provides a more comprehensive and detailed view.
- Benchmarking
Lastly, it is a valuable index for determining the actual returns offered by a security. It can be used to create benchmarks for the performance of individual stocks and exchange-traded funds (ETFs).
Total return index vs price return index
It is crucial to understand the difference between the total return index and the price return index to understand the utility of both these indexes thoroughly. The key differences that separate their usage include:
| Features | Total Return Index(TRI) | Price Return Index(PRI) |
| Components | Interest, price changes and dividends | Only price changes |
| Accuracy | Comparatively more accurate reflection of the returns | Only the price movements are tracked and might not reflect the complete return |
| Relevance | Mostly used for evaluating performances and benchmarking mutual funds | Used mostly for tracking the price movements |
| Transparency | Very transparent and reflects the total gain or loss | Might not reflect the accurate gain or loss |
Conclusion
The total return index is a valuable index that provides insight into the price movements as well as the dividends. It provides an accurate representation of the past performance and returns of security to help investors make a decision.
Owing to its key features such as benchmarking mutual funds and helping with long-term investment planning, this index is increasingly gaining importance. Use the index to assess the potential returns from all the investments you plan to invest in. To learn more financial concepts, subscribe to StockGro blogs.
FAQs
It is crucial to consider the total return index because it helps assess the return from security before investing in it. It considers both, the change in the asset price as well as the dividends and helps make informed investment decisions.
Yes, dividend reinvestment is included in the index to benefit from the compounding effect and calculate the total return of an investment.
Yes, some assets might have a negative total return index if the losses exceed the capital gains. It implies that the investment was not profitable at all.
The benefits of calculating the total return index include accurate measurement, better comparison, long-term perspective and benchmarking.
Yes, the total return index is different from the price return index in that it provides better insight into the investment return by accounting for price changes, interest and dividends while the price return index only considers the price change.
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