Total Return Index (TRI) is a stock market index that measures the comprehensive performance and returns, including capital gains and cash distributions like interest, dividends, and more, of the securities it comprises. Assessing an index’s securities with TRI helps investors obtain a clear picture of index performance to plan investments accordingly.
In this article, we will explain the meaning of the total return index, along with an example, its formula, calculation, and advantages. We will also discuss several aspects of the differences between the total return index and the price index.
What is the Total Return Index (TRI)?
The total return index is a stock market benchmark that helps investors understand the performance and returns from stocks that comprise a given TRI index. It is important as it includes overall gains, including gains from price changes and income distributions. The TRI operates under the assumption that all derived dividends will be reinvested. Several benefits to investors have been observed with the implementation of the total return index vs. price index, as the latter only takes into account the capital gains. It is important to know the differences between the two metrics, as it will help you make an informed decision regarding your investments and portfolio.
Also read: What Is Compound Annual Growth Rate (CAGR)
Total return index example
Perhaps the most prominent example of a total return index globally is the S&P 500. The index has a variation known as the S&P 500 Total Return Index, which is distinct from the normal S&P index. The standard S&P index also excludes cash distributions.
How to calculate the total return index?
With the meaning of the total return index clear, let us take a look at its calculation. Its formula is:
| TRI = Previous day's TR × [1 + {(Present day PR index + Indexed dividend) / Last day's PR index} - 1] |
The steps for the calculation are described below:
Step 1
To find the indexed dividend, divide the dividend payout by the index’s base cap, which determines the index's numerical value.
Step 2
With the indexed dividend clear, the next step is to adjust the price return index (PRI) according to the present or given day. For this, add the indexed dividend and the price index in the formula below:
(Present day’s price return index + Indexed dividend)/(Previous price return index)
Step 3
Now, it is time to plug in the adjustments made to the PRI and TRI. The result is multiplied with the last day’s TRI, bringing us to the formula:
| TRI = Previous day's TR × [1 + {(Present day PR index + Indexed dividend) / Last day's PR index} - 1] |
Also read: What Is Systematic Withdrawal Plan (SWP)
Advantages of total return index vs price index
Let us look at some of the major advantages of the total return index.
1. Precise assessment
Price movements are the major indicators for most retail investors. With the TRI including cash income distributions as well, it widens the scope of assessment of index performance and helps investors get a precise measurement of their expected returns.
2. Benchmarking against fund managers
With TRI, you can compare your returns from investing in mutual funds with the funds that professionals manage. In this manner, you can accurately compare the success of your investments with the investments of professional fund managers.
3. Long-term outlook
The total return index vs. price index is a better indicator for investors to plan long-term investments. TRI investments can fetch significant returns in the long run as they can better measure the performance of index stocks compared to the price return index.
4. Benchmarking
The total return index vs. price index may be more useful for assessing the actual returns from investments in mutual funds. However, besides this, the TRI can also be leveraged to measure returns from individual stocks and exchange-traded funds (ETFs).
Tips for using total return index vs price index
While employing the use of total return index vs. price index, it is important to keep in mind the following points.
1. Select the appropriate benchmark
It is vital to compare and choose a scheme by looking at the index it is following. In the financial market, various mutual fund schemes follow different TRI benchmarks. For instance, while one mutual fund scheme may track the Nifty 100 total return index, another may mimic the S&P 500 total return index. This information can be easily located in scheme documentation and must be carefully analysed against your own financial objectives.
2. Looking beyond the total return index
Even though a metric like TRI can be significant, it is not everything. It is highly recommended that you base your investment decisions by taking into consideration other factors like the track record of your fund manager, expense ratio, and most importantly your risk appetite and investment goals.
3. Assumption of reinvestment
By now, it must be abundantly clear that the total return index always assumes that dividends will be reinvested. In the case of mutual funds and equity-based funds, it is assumed that your cash payouts are reinvested back into the fund. On the other hand, when it comes to bond indexes, TRI assumes that cash distributions like coupon payments will be utilised by an investor to buy more bonds in the same fund.
Total return index vs price index
There is another term you would have read along with the total return index, which is the price return index. Total return index vs. price index has significant differences that are laid out in the table below:
| Aspect | Total return index | Price return index |
| Components | Includes capital gains, interest, dividends | Only tracks capital gains |
| Measurementaccuracy | More accurate | Less accurate, tracks partial returns |
| Relevance | Relied on for comprehensive performance and return assessment | Relied on majorly for tracking price movements |
| Trust | More trustworthy as it measures precise returns | Prone to overstating returns, which can mislead investors |
| Use | Used as an index for mutual funds | More traditional approach and less use in modern-day trading |
Key highlights
The total return index is calculated by accounting for capital gains as a result of stock price changes as well as income distributions like interest and dividends to compute a holistic performance and return value for an index.
TRI operates under the assumption that all derived dividends are reinvested.
To calculate the TRI, you need to first determine the dividend per index point and adjust the price return index. Then, you have to update the TRI index level from the day before the present.
The total return index can now be used to assess mutual fund performance. Earlier, the price return index was used, and it excluded cash distributions entirely.
Conclusion
The Total Return Index (TRI) provides a comprehensive measure of stock market performance, incorporating capital gains and cash distributions like dividends. Understanding the total return index vs. price index offers investors an option for accurately assessing expected returns and serves as a reliable benchmark for comparing index performance and investment returns. For investors, understanding its calculation and advantages can be crucial in making informed investment decisions aligned with their long-term financial goals.
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