– By Gyan Anand, T. A. PAI MANAGEMENT INSTITUTE, Manipal


“Sir, our scheme has beaten the nifty year on year”

“Our fund manager has a reputation for generating regular alpha”

Claims as these by investment firms, mutual funds, or insurance providers are regularly seen. The clients often fall for it as they see these claims as something done right by the managers.

However, there exists a catch to this, general understanding. The aim of this paper is to remove the exploitation done, using such claims by companies.

Stock Index

The practice of using a set of stocks to represent the performance of the market was started by Charles H Dow, a financial journalist in 1896, who built the first stock market index The Dow Jones Industrial Average, which was an average of the top 12 stocks in the market. This index was calculated by taking all of the stock prices, adding them together and then dividing them by the number of stocks.

The methodology has changed with the passage of time but the true sense of the index remains intact. Today almost all the major indexes in the world are price indexes, including likes of S&P 500, Nifty, Dow Jones, NASDAQ etc.

The index provides a benchmark against which performance of various investment opportunities is measured. It is a tool which is put to use by investors, financial managers and the likes of them to describe the market and measure performances and returns on various instruments. For instance, mutual funds create portfolios which are actively managed by portfolio managers. When an investor needs to measure which mutual fund has better performance, he needs a benchmark, this is where the ‘Indices’ come in handy. Since an index is a mathematical construct it cannot be traded directly, so various instruments try and imitate the index and if possible beat it (generate alpha).


An index consists of a selected number of stock which represents the sector to which it belongs, i.e. Healthcare, Pharmaceuticals etc. Generally, these are the major players in the market. These stocks are selected based on various parameters such as liquidity, market capitalization to name a few. Nifty 50 consists of 51 stocks, Sensex consists of 30 stocks, Dow Jones is a 30 stock index while S&P 500 is a 505 stock index.

The two most common kinds of indices are – Price-weighted and market capitalization weighted index.

A price-weighted index is calculated by adding the prices of each of the stocks in the index and dividing them by the total number of stocks. Stocks with a higher price will be given more weight and, therefore, will have a greater influence over the performance of the index. Some examples of price-weighted indices are the Dow Jones Industrial Average in the United States and the Nikkei 225 in Japan.

A market capitalization weighted average is calculated by taking into consideration both the size and the price of the stock. In an index using market-capitalization weightage, stocks are given weightage on the basis of their market capitalization in comparison with the total market capitalization of the index. In the case of Free Float method, the calculation is done by multiplying only those shares that are held by the public (non-promoters). In India, the indices are calculated based on the free float method.


Figure 1: Market Capitalization weighted index calculation

However, a price index does not consider the returns that would arise out of dividend receipts, it takes into account only the capital gains arising from price movements of the underlying stocks.

Since dividends are paid to shareholders, indices which are nothing but model portfolios, do not hold any share and hence they ignore the dividends.


Total Return Index

The vast majority of financial tools available on the internet do not seem to report total returns, but rather only price returns. For example, when you plot the relative performance of two mutual funds or exchange-traded funds (ETFs), only the price history of the two assets is compared, excluding any dividends received (whether reinvested or not). This is a huge deficiency when comparing funds containing a large fraction of bonds, for which such distributions are typically more important than for stocks.

So to overcome this deficiency there exists an index called the Total Return Index.

A Total Return Index (TRI) is a type of index which measures the performance of a group of stocks assuming that all cash distributions such as dividends are invested back. This is a better way to look at the performance of the stocks, and is far more accurate. By assuming that dividends are reinvested, it also accounts for companies that don’t pay a dividend and instead reinvest the earnings in the company.

A TRI represents what an investor actually gets by investing: the return of the index and dividend paid and reinvested in the index.

When a company pays out a very high dividend or gives bonus shares or splits its shares, the index gets normalized (over 10% of market price), however, the dividends paid normally are not this high, they are quite meager.

The below chart shows nifty dividend yields over the years.


Figure 2: Nifty dividend yields 2000-16

While prima facie it may seem that dividend of a percent or two doesn’t make much of a difference to the overall performance, however, the research proves otherwise.While the difference is very small, but given the power of compounding this turns out to be quite a large difference, and ignoring this might prove to be detrimental.All major indices publish their Total Return Index using which we can determine the effect of reinvested dividends.

For instance, value of Nifty, today is say 9520, whereas Nifty TRI which considers reinvested dividends is at 12932. Similarly DJIA today is at say 21829 whereas DJIATRI is at 46598.This negates the assumption or mindset that dividends are too small to make an impact.


Figure 3: NIFTY 50 vs  NIFTY 50 TR. Source : NSE website.

 If we would have invested ₹100 in Jul 1999, Nifty would have fetched us ₹726.70, which is a 7.26 X increase to the sum and a profit of ₹626 in about 18 years.

On the other hand, similar investment including dividend reinvested fetches ₹932.40, which is a 9.32 times increase to your principal and a profit of 832% in about 18 years.


Figure 4: DJIA vs DJIA TR. Source : S&P Dow Jones Indices website.

In lines similar to NIFTY, if we would have invested ₹100 in March 2007, DJIA would have fetched us ₹176.69, which is a 1.77 X increase to the sum and a profit of 76 % in about 10 years.

On the other hand, similar investment including dividend reinvested fetches ₹231.85, which is a 2.31 times increase to the principal and a profit of 131% in about 10 years. The same holds true with S&P 500 as well, if we would have invested ₹100 in August 2012, S&P500 it would have fetched us ₹175.75, which is a 1.76 X increase to the sum and a profit of 76 %in about 5 years.

On the other hand, similar investment including dividend reinvested fetches ₹194.97, which is a 1.95 times increase to the principal and a profit of 95% in about 5 years.


Figure 5: S&P 500 vs S&P 500 TR. Source: S&P Dow Jones Indices website

Mutual funds and other financial instrument providers use the base index i.e. Nifty, S&P500, and DJIA etc. to support their claims of excess alpha.

The lower returns of the base index makes the funds seem like a genius, which they are not, in reality. Noteworthy is the fact that out of the 48 large cap funds, with track records of at least 10 years,79% have beaten Nifty but only 60% beat Nifty TRI, despite the fact that the annualized difference is just 1 odd %.


 The aim of a total return index is to provide full value of an investment that an investor would take home. This means reinvesting the dividends by adding them, period to period, to the price changes in the index portfolio.

But how can we add dividends which are expressed in Rupees, Dollars, Pounds to an index which is expressed as a point? NSE provides the answer to this question.

The trick is pretty much what we learned in school establish a common denominator. This is done by dividing the dividends paid over a period by the same divisor used to calculate the index.  This gives the “dividends paid out per index point.”

formula 1

The next step is to adjust the price return index value for the day, using the below formula, which combines the dividends and index price change.

formula 2

We now reinvest the Indexed dividends in the index to give TR Index.

formula 3

The base for both the Price index close and TR index close will be the same.


The Total Return, including dividends, is what we must use as a real benchmark for periods of more than 2 years. In fact, all index funds can use this as a benchmark – they are most probably going to buy underlying stocks, and will earn dividends that they, as a rule, have to reinvest.

So the next time an index—likely a price return index—hits a major milestone and is noted in the media, take the time to go to the S&P Dow Jones Indices website to see how the total return version of this same index performed.  With dividends included, the index will have done even better than the analysts and journalists are acknowledging.


  1. What are stock market indices? Retrieved July 29, 2017 from Kotak securities website: https://www.kotaksecurities.com/ksweb/Research/Investment-Knowledge-Bank/what-are-stock-market-indices
  2. Index Basics: Calculating an Index’s Total Return (2017, February 7). Retrieved July 30, 2017, from Indexology blog: https://www.indexologyblog.com/2017/02/07/index-basics-calculating-an-indexs-total-return/
  3. Freefincal, The magic of reinvested stock dividends! (2016, November 23). Retrieved July 30, 2017, from https://freefincal.com/total-returns-index-reinvested-dividends/
  4. Deepak Shenoy, The Total Return Index: Nifty Including Dividends (2013, April 30). Retrieved July 30, 2017, from https://capitalmind.in/2013/04/the-total-return-index-nifty-including-dividends/
  5. How ‘Total Returns’ are calculated (2007, January 22). Retrieved July 28, 2017, from http://allfinancialmatters.com/2007/01/22/how-total-returns-are-calculated/
  6. Beattie, How Stock Market Indexes Changed Investing (2007, April 12). Retrieved July 30, 2017, from Investopedia: http://www.investopedia.com/articles/07/history-indexes.asp
  7. Nasdaq Total returns. Retrieved from Nasdaq website: http://www.nasdaq.com/markets/indices/nasdaq-total-returns.aspx
  8. SP500NTR Charts – S&P 500 NET Total Return Index Interactive Charts. Retrieved July 30, 2017, from Market watch website: http://www.marketwatch.com/investing/index/sp500ntr/charts?countrycode=xx
  9. Dow Jones Industrial Average. Retrieved July 30, 2017, from S&P Dow Jones Indices: http://asia.spindices.com/indices/equity/dow-jones-industrial-average
  10. Dow Jones Industrial Average Total Return. Retrieved July 30, 2017, from Google Finance: https://www.google.com/finance?cid=1881853
  11. Schick, K. An Introduction to Stock Market Indices (2017, April 27). Retrieved July 29, 2017, from Investopedia: http://www.investopedia.com/articles/analyst/102501.asp
  12. Dow Jones Average & Total Return Indexes (2017, June 01). Retrieved July 30, 2017, from http://www.whartonwrds.com/datasets/dow-jones-average-tri/
  13. Tipping point: How is a total return index different from a normal index? (2017, May 11). Retrieved July 30, 2017, from http://www.business-standard.com/article/pf/tipping-point-how-is-a-total-return-index-different-from-a-normal-index-117051001508_1.html
  14. Krish, P, Introduction to Total Returns Index (2017, June 27). Retrieved July 30, 2017, from https://capitalmind.in/2017/06/introduction-to-total-returns-index/
  15. Total Returns Index (2007, May 30). Retrieved July 30, 2017, from http://www.investopedia.com/terms/t/total_return_index.asp
  16. Price Return vs. Total Return (2012, February 24). Retrieved July 30, 2017 from https://jblevins.org/log/total-returns


About the Author:



Gyan Anand is a finance major student, from the PGDM batch of 2016-18, at TAPMI, Manipal. His areas of interests are corporate finance and the financial markets.He holds a certificate in Forensic Accounting from the West Virginia University and is a certified Research Analyst from NISM.

You can contact him at: gyananand1693@gmail.com


%s Comment

  • nicely analyzed.I particularly liked the usage of dividend yield across years to drive the point.
    Scheme level granular analysis can be considered for further improvement, these statistics are very interesting!! I’ll share links soon.

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