Total return index

A total return index is an index that measures the performance of a group of components by assuming that all cash distributions are reinvested, in addition to tracking the components' price movements.[1] While it is common to refer to equity based indices, there are also total return indices for bonds and commodities.[2]

A total return index (TRI) is different from a price index. A price index only considers price movements (capital gains or losses) of the securities that make up the index, while a total return index includes dividends, interest, rights offerings and other distributions realized over a given period of time. Looking at an index's total return is usually considered a more accurate measure of performance.[1]

Many stock indexes are calculated as a price index and a performance index as well: Examples are the German stock market index DAX[3] and the S&P 500[4]

The TRI is also used to develop a portfolio as a weighted combination of assets, as it is described in modern portfolio theory. Though this theory is working with historical data, the models following this theory are trying to calculate the expected return based on a selected combination of assets. For example, in this way a stock portfolio representing a part of a stock index can be compared with the performance version of the stock index.

In 1992 Tweedy, Browne Co. computed the investment return in excess of or (less than) the equal weighted NYSE Index over the subsequent four years for all of the stocks in each selection period. The four-year returns in excess of or (less than) the market index were averaged. The compound annual return (investment return, discounted retroactively from a cumulative figure, at which money, compounded annually, would reach the cumulative total) in excess of the market index from the lowest 20% of the stocks, in terms of price/book value, was 8.91%. For each $1,000,000 invested, the low price/book value stocks returned $407,000 more on average than the market index in each four-year period.[5]

References

  1. 1 2 What is total return index? definition and meaning InvestorWords.com. Retrieved November 21, 2011.
  2. ↑ Total Return Index Definition Investopedia. Retrieved November 21, 2011.
  3. ↑ DAX: Stock Index Summary Bloomberg. Retrieved November 21, 2011.
  4. ↑ S&P | S&P 500 | Americas standardandpoors.com. Retrieved November 21, 2011.
  5. ↑ What Has Worked In Investing: A Tweedy Browne Case Study, Tweedy, Browne Co., LLC
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