Price Return and Total Return Are Two Different Indices

The same index, published twice

Kabir sees the Nifty quoted at some level on the news. The fund he holds reports its return against "the Nifty 50". He assumes these are the same reference. They usually are not.

An index tracks the value of a defined basket of shares. The complication is dividends: companies pay some of their earnings out to shareholders, and the index has to decide what to do about that money.

A price index ignores it. When a company pays a dividend, its share price drops by roughly the amount paid, and the price index simply records the drop. The cash that went to shareholders has left the index and is not accounted for anywhere.

A total return index assumes the dividend is immediately reinvested back into the basket. It therefore captures both what the prices did and what the payouts added.

Both are honest measures of different things. The price index answers "what are these shares worth"; the total return index answers "what happened to a shareholder". Only the second describes anyone's outcome, because a real shareholder receives the dividends.

Why the gap grows quietly

Over a single day the difference is invisible. Over decades it is not, because the payouts compound.

Each year the total return index gets the dividends and the price index does not, and the total return index then earns returns on those dividends in every subsequent year. The gap between the two therefore widens by more each year, in the same way that any compounding difference does. It is the same arithmetic that makes an annual charge so consequential over a long holding period — how investment fees reduce wealth works through that identity in the other direction.

The practical consequence is that the longer the comparison period, the more a price-index comparison flatters whatever is being compared against it. A fund shown against a price index over twenty years is being given a large head start, silently.

Where this actually bites

Fund marketing. A fund compared against a price index gets credit for the dividends its own holdings received. Since the fund does receive them and the index does not, some of what looks like skill is simply the comparison being wrong. Whether a fund is beating its benchmark is a question that cannot be answered until you know which version of the benchmark was used.

Index funds and ETFs. These will always appear to lag their index if you compare them against a total return index — because they charge a fee and incur costs — and may appear to beat it if compared against a price index. Neither comparison tells you whether the fund is tracking well. That question needs the total return version and a proper measure of the shortfall, which is tracking error against tracking difference.

Any long-run "what the market returned" claim. Historical return figures quoted from a price index understate what a shareholder actually received. Figures quoted from a total return index are the fair ones, and they are also higher, so it is worth knowing which you have been given before you plan against it.

Your own return. If you own funds, you are on the total return side of this: the dividends your funds receive are reinvested inside them. Comparing your portfolio against the level of the index you saw on television is comparing yourself against a measure that has thrown away part of the return.

What we do on this site, and what we cannot show you

Every market figure on this site comes from a total return series, with dividends included. That is recorded for every article that uses one, and it is why our historical return figures are higher than ones you may see quoted elsewhere from the headline index.

What we cannot do is show you the size of the gap. Quantifying it would need the price index for the same period alongside the total return index, and we hold only the total return series. So no figure appears above for how much dividends have added in India, and none should be added from a remembered dividend yield — a plausible number in the place where the article's whole point sits would be exactly the fabrication this site exists to avoid.

What can be said without the data is the direction, which is not in doubt: the total return index is higher, and the gap grows with the length of the period.

What to check

When you are shown a fund against a benchmark, ask which version of the benchmark. The words "total return", or the initials TRI, should appear somewhere. If they do not, ask.

When you see a long-run figure for what the market returned, ask the same thing. A figure from a price index is not wrong, but it is not what a shareholder got.

And when comparing your own holdings, compare like with like: your funds reinvest dividends, so the fair reference is the total return index. Comparing yourself against the number on the news will make you look better than you are, which is a pleasant error and still an error.

What to take away

Two indices, almost the same name, systematically different levels. The price index leaves out dividends; the total return index reinvests them; the gap compounds and grows with time.

Every comparison you are shown depends on which one was used, and the version that flatters the person showing it to you is the one they are least likely to name.