What Is The 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.

Total Return Index Meaning

A total return index (TRI) measures how well an index or stock portfolio performs, taking into account both price changes and dividend payments. It is used as a benchmark to calculate the fund's performance. TRI shows how dividends can enhance your investment returns, assuming that all dividends are reinvested for better growth.

In simple words, it gives a complete view of the investment performance by combining capital gains and dividends. Unlike the price index, which only captures the price movements, the TRI measures every part of the returns.

Characteristics Of TRI

The major characteristics of TRI are as follow.

• Comprehensive Measurement - TRI provides a complete view of investment returns, including the capital gains, dividends, or interest.

• SEBI Rule - In 2018, SEBI made it mandatory for mutual funds to benchmark their performance against TRI instead of PRI. It helps ensure fair comparison and builds investor trust.

• Reinvestment - TRI assumes that any income generated is reinvested into the index.

• Transparency - It provides a clear and realistic view of a fund’s performance over time.

• Long-term Use - TRI can be used to evaluate the fund's performance over the long-term.

Calculating the Total Return Index

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]

Total Return Index vs Price Return Index

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 indices. Here's a table highlighting some of the major ones.

Advantages of Total Return Index

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.

Tips For Using Total Return Index (TRI)

If you are considering using the Total Return Index (TRI), these tips will help you track your mutual fund's performance.

TRI for long-term investing

If you are planning a long-term investment, TRI can provide a more accurate and clear representation of investment returns. It does so by including both price changes and reinvested dividends. Moreover, it shows how dividend reinvestment can grow your returns over time.

Compare with mutual funds

Always compare the performance of mutual funds or ETFs with the total return index, as it provides a fairer comparison than PRI. TRI gives a more accurate measure of actual returns, including the dividends. It is an ideal metric to check if the investment is underperforming or overperforming.

Avoid the misleading comparison

Using a Price return index to compare your returns can be misleading, as it ignores dividend reinvestment. For a dividend-paying investment, using TRI will provide a more realistic picture of actual returns.

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.