What is Total Return Index?

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  • 29 Dec 2023
What is Total Return Index?

Key Highlights

  • Total Return Index (TRI) takes into account dividend payments and changes in stock prices to calculate the returns on equity indexes.

  • It assumes that all dividends are reinvested. So, it offers investors a clear picture of their return on investment.

  • You need to find the dividend per index point and balance the price return index to calculate TRI. Then, you will have to adjust the TRI index level to the previous day,.

  • You can now use the TRI for benchmarking mutual funds. This is because they consider capital gain or loss and the dividends. The conventional method of price return index (PRI) considers price action only.

The total return index (TRI) is a benchmark to determine the actual returns for the underlying assets of a mutual fund. It measures both dividend returns and capital appreciation. It illustrates how dividend payments affect the profits of investors. TRI assumes that all the dividends were reinvested.

Instead of just the price changes, overall returns are included. It measures the performance of an index by tracking capital gains along with payouts such as dividends or interest. As a result, it provides investors with a complete view. The total return index takes into account all equities that reinvest their dividends back into the company. It assumes that they were reinvested.

Now, that you know the total return index definition, let’s see how to calculate it. The formula for the total return index is as follows.

Total Return Index = Previous TR * [1+(Today’s PR Index +Indexed Dividend/Previous PR Index-1)]

One can find a total return index using values in dollars, euros, or other currencies. The calculation involves the following steps.

Step 1: Divide the dividends paid by the base cap of the index. Base cap is used to find the points of an index. It gives the dividend payment value per index point, as shown in the following equation:

Indexed dividend (Dt) = Dividend Paid out / Base Cap Index

Step 2: Next adjust the price return index for a given day. To do this, add the dividend and price change index. So,

(Today’s PR Index +Indexed Dividend)/Previous PR Index

Step 3: Apply the modifications made to the price return index to the total return index. Multiply the result with the TRI index of the previous day. It is represented by the following formula:

Total Return Index = Previous TRI * [1+ {(Today’s PR Index +Indexed Dividend)/Previous PR Index}-1]

The words "price index" and "total return index" refer to two separate indexes. They are used for two different objectives. It's vital to comprehend the difference between these indexes. Here's a table highlighting some of the major ones.

Feature Total Return Index (TRI) Price Return Index (PRI)
Components InvolvedPrice changes, dividends, interestOnly price changes
AccuracyMore accurate reflection of actual returnsTracks only price movements, may not reflect complete return
RelevancePreferred for benchmarking mutual funds and evaluating performanceMore traditional approach, mainly for price movement tracking
TransparencyMore transparent, reflects total gain/lossMay overstate performance, potentially misleading investors
Recent AdoptionIncreasingly used as the benchmark for mutual fundsLess common in modern investment evaluation

Here are the advantages of the total return index.

  • Accurate measurement: Retail investors usually focus only on price movements. However, TRI considers the impact of dividends and interest income. So, it provides a more comprehensive view of actual returns.

  • Comparison with Fund Managers: Retail investors may use TRI to compare their mutual fund returns to the funds managed by professional fund managers. So, TRI is a more precise way to compare the success of various investments.

  • Long-Term Perspective: Using TRI will greatly impact the long-term strategy of investors. It is a more accurate way to measure the performance difference than the PRI.

  • Benchmarking: TRI is a more useful benchmark for determining the real returns offered by stocks in a mutual fund. In addition, investors can also use TRI to analyse the performance of exchange-traded funds (ETFs) and individual stocks.

Conclusion

TRI measures the changes in asset prices as well as their dividend payments. Mutual fund NAVs account for dividends and capital gains from underlying assets. TRI provides an accurate representation of the actual earnings of a fund. In addition, the Securities and Exchange Board of India (SEBI) made it mandatory for mutual funds to use the TRI as a performance benchmark from February 1, 2018. So, investors should understand how this metric works to optimise their investments for the best returns.

FAQs on What is Total Return Index

The total return strategy more accurately determines the performance of a security. It considers changes in asset prices along with the income generated.

Dividends are reinvested back into the index. This allows investors to benefit from the compounding effect of reinvested income. The reinvestment amount is a key factor in calculating total return.

Yes, the total return can be negative. It happens if capital losses and reductions are more than the income generated by an investment. This indicates an overall loss on the investment.

Yes, different asset classes have different total return indices. Each type of TR index shows the total return for its specific asset class.

Yes, TRI is very useful for long-term investing. It also helps you to assess the historical performance of investment portfolios.

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