Total Return Index vs. Price Return Index: What is the difference?

If you’re new to investing, you might have come across terms like Total Return Index and Price Return Index. At first glance, these concepts can seem complicated, but they’re not as difficult as they sound. Understanding these two types of indices is important because they help you measure how your investments are performing. Whether you're tracking the Nifty or any other index, learning about the Total Return Index vs. Price Return Index will give you deeper insights into your investment journey.
In this article, we'll take a closer look at these concepts, so that you can understand how best to use them to maximise your gains.
- Table of contents
- What is the Total Return Index (TRI)?
- Total Return Index example
- How to calculate the Total Return Index
- Advantages of Total Return Index vs. Price Index
- Tips for using Total Return Index vs. Price Index
- Total Return Index vs. Price Return Index
What is the Total Return Index (TRI)?
The Total Return Index, or TRI, measures the total returns an investor would earn if they reinvested all dividends back into the index. It provides a more comprehensive view of investment performance, capturing both price appreciation and dividend income. Unlike the Price Return Index, which considers only changes in stock prices, TRI factors in the reinvestment of dividends, making it an essential tool for evaluating the true growth of an investment over time.
What makes TRI special is that it doesn’t just look at how stock prices move; it also includes the dividends paid by the companies in the index. This means it reflects the full earnings potential of your investments. Moreover, TRI shows the real returns from your investments, offering a better benchmark for performance comparison.
For example, if a stock pays a 2% dividend, the TRI will include that dividend in its calculation, unlike a Price Return Index, which omits it. Over time, this inclusion highlights the compounding effect of reinvested dividends, giving a clearer picture of long-term wealth creation.
In 2018, SEBI mandated the use of the Total Return Index (TRI) instead of the Price Return Index (PRI) as the benchmark for mutual funds. This change aimed to provide a more accurate representation of a benchmark's performance by including both price appreciation and dividend reinvestment, aligning better with mutual fund returns.
Total Return Index example
Let’s consider a simple example:
Imagine a stock index starts at 1,000 points. Over a year, the prices of the stocks in the index rise by 5%, and the companies in the index pay a total dividend yield of 2%.
- The Price Return Index will show a 5% return, increasing the index to 1,050 points.
- The Total Return Index, however, will include both the 5% price return and the 2% dividend yield.
This example shows how the Total Return Index gives you a more accurate idea of the full returns on your investment.
How to calculate the Total Return Index
Calculating the Total Return Index (TRI) might sound difficult, but here’s a simple breakdown of the process:
- Start with the Price Return Index: Begin with the base index that tracks the changes in stock prices over time, excluding dividends.
- Add the dividend component: Incorporate the dividends paid by the companies within the index. This step assumes that all dividends are reinvested back into the index, which simulates how returns grow when reinvestment is factored in.
In mathematical terms:
Total Return Index = Previous Total Return * [1 + (Today's Price Return + Indexed Dividend / Previous Price Return - 1)]
Where:
- Previous TRI: Total return index value of the previous day.
- Today's price: The price of the asset for the current day.
- Indexed dividend: The dividend adjusted for reinvestment at today's market price.
- Previous price: The price of the asset for the previous day.
Here are the steps:
Step 1: Calculate Indexed Dividend
Determine the dividend payment value per index point by dividing the total dividends paid by the index's base capitalization:
Indexed Dividend = Total Dividends Paid ÷ Base Cap Index
Step 2: Adjust Price Return Index
Combine the day's price change and indexed dividend by adding them and dividing by the previous day's price return index:
Adjusted Price Return = (Today's Price Return + Indexed Dividend) ÷ Previous Price Return Index
Step 3: Compute Total Return Index
Apply the adjusted price return to the previous day's Total Return Index:
Total Return Index = Previous Total Return Index * [1 + {(Today's Price Return + Indexed Dividend) ÷ Previous Price Return Index} - 1]
Advantages of Total Return Index vs. Price Index
Here are some benefits of using the Total Return Index (TRI):
1. Complete performance picture: TRI accounts for both price changes and dividends, giving a more comprehensive view of the total growth of your investment. It reflects the true returns an investor earns, considering both capital appreciation and income from dividends.
2. Better comparison: When comparing mutual funds, ETFs, or investment portfolios, TRI serves as a fairer and more accurate benchmark. By including reinvested dividends, it ensures comparisons reflect the actual returns an investor might experience.
3. Accurate benchmarks: For active investors and fund managers, TRI is a crucial tool for performance evaluation. It helps determine whether a fund manager has genuinely outperformed or underperformed the market, as it includes the commonly overlooked impact of dividends.
On the other hand, the Price Return Index only reflects stock price movements, ignoring the contribution of dividends to total returns. This omission can provide an incomplete or misleading picture of an investment’s performance, particularly over the long term, where reinvested dividends significantly enhance returns.
Tips for using Total Return Index vs. Price Index
Here are some practical tips to make the most of these indices:
1. Use TRI for long-term investing: When planning for long-term financial goals, the Total Return Index (TRI) provides a clearer and more accurate representation of your investment returns. By including both price changes and reinvested dividends, TRI captures the compounding effect of dividends over time, which can significantly enhance returns in the long run.
2. Compare with mutual fund performance: Always benchmark mutual fund or ETF performance against the TRI rather than the Price Return Index. This ensures a fair comparison, as TRI reflects the actual returns an investor might receive, including dividends, making it the ideal metric for evaluating whether a fund is underperforming or outperforming.
3. Understand your index: Before making investment decisions, check whether the index you’re tracking is a Price Return Index or a Total Return Index. This clarity is essential for setting realistic return expectations and understanding the true performance of your portfolio.
4. Avoid misleading comparisons: Using a Price Return Index as a benchmark can lead to underestimating your potential returns, particularly in dividend-rich indices. For dividend-focused strategies or income-generating investments, TRI provides a more realistic performance measure.
By aligning your analysis and decisions with the right index, you can better assess portfolio performance, set accurate goals, and maximise long-term gains.
Total Return Index vs. Price Return Index
The following is a summary of the key differences between Total Return Index vs. Price Return Index:
Total Return Index | Price Return Index | |
---|---|---|
Definition | Measures total returns, including dividends | Tracks stock price changes only |
Includes dividends? | Yes | No |
Performance reflection | Complete | Partial |
Suitable | Long-term comparisons | Investors who are withdrawing dividends |
In essence, the TRI gives a more holistic view of investment returns, while the Price Return Index is limited to stock price changes.
Conclusion
Understanding the Total Return Index vs. Price Return Index is key to making informed investment decisions. While the Price Return Index shows only how stock prices are performing, the Total Return Index goes a step further by including dividends. This makes TRI a better tool for long-term investors and a more accurate benchmark for assessing investment performance.
So, the next time you’re evaluating your investments or comparing mutual funds, keep the TRI in mind. It’s your gateway to truly understanding how your money is working for you.
FAQs
What is the Total Return Index?
The Total Return Index is a measure of an index’s total growth, including price changes and reinvested dividends.
What is the Nifty Total Return Index?
The Nifty Total Return Index is a version of the Nifty index that reflects both stock price movements and dividends, providing a fuller picture of investment returns.
How do you calculate the Total Index Return?
The Total Return Index is calculated by adding the dividend yield to the Price Return Index, assuming dividends are reinvested back into the index. The formula is Total Return Index = Previous Total Return Index * [1 + {(Today's Price Return + Indexed Dividend) ÷ Previous Price Return Index} - 1]
What is the difference between the Total Return Index and an Excess Return?
The Total Return Index includes dividends and measures total returns, while the Excess Return measures the return above a specific benchmark, such as a risk-free rate.
How does the Total Return Index differ from a Price Return Index?
The Total Return Index includes both stock price changes and dividends, whereas the Price Return Index only considers stock price changes.
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