What Is a Total Return Index?

A total return index is an index created to track both capital appreciation and dividend returns. The index reinvests all dividends. Using total return is a way to include every part of the return and not just price movement.

Total return indices are used to show the impact dividends have on an investor’s return. Let’s go over how they work and the difference between total return indices and total return investment strategy.

Definition and Examples of a Total Return Index

A total return index is an index that reinvests dividends to produce returns from both capital appreciation and dividends. Total return indices are used to show the impact of dividends on return to shareholders. The return of the index considering only capital appreciation is called price return. Many ETFs advertise both price and total return in their prospectus.

The most popular total return index is the S&P 500 total return index (SPTR). The S&P 500 is a collection of the 500 largest stocks in the US. The index is widely used as a representative of the US economy as a whole because it tracks a diversified sample of companies that represent every corner of the economy.

Total return is important to consider as an investor because it doesn’t penalize some stocks for how they choose to handle capital allocation. For example, if Stock A spends $10 million buying back shares and Stock B spends $10 million paying dividends, A’s price will increase because of the increased demand for shares but shareholders of B still have a return that may even be higher.

How a Total Return Index Works

Total return indices work by reinvesting dividends when they’re paid. Let’s go through an example. You buy one share of a total return index at $50 on January 1. The index offers a $4 annual dividend that pays in $1 increments in each quarter. By December, the stock has risen 20% to $60. Your price return is 20%. But since the index paid you $4 in dividends and you reinvested them and gained an additional $1 in value, your initial investment is now worth $65. While your price return is 20%, your total return is 30%.

You can find the index total return on a website such as YCharts by searching for the index you want and then looking for the total return. Each total return index has a ticker symbol that’s different from its non-total-return index iteration.

Total Return Index Vs. Total Return Strategy

Total return strategy, or income investing, is a popular retirement investment strategy that has some things in common with total return indexes but is a different concept altogether. Total return strategy is a strategy that focuses on increasing income for investors.

Investors or fund managers following a total returns strategy would focus on only high-dividend-paying stocks and fixed income instruments such as bonds. This is an effective strategy in retirement because it produces income for the investors to live on while preserving and hopefully growing the capital base for future years.

An example of the total return strategy is the T. Rowe Price Total Return ETF (TOTR). The ETF seeks to maximize income first and capital appreciation second by investing in fixed income and other debt instruments.

Although different, total return strategy and index highlight the impact of dividend income on investment return.

What It Means For Individual Investors

Total return indices are an effective way for individual investors to compare their own returns and the returns of a prospective investment manager with indices such as the S&P 500. The Financial Industry Regulatory Authority (FINRA) recommends using total return to evaluate investment performance between different investments opportunities because it is the most accurate measure of return on investment.

Including dividends when comparing performance is important even when one or both options aren’t high dividend payers. From 1970 to 2020, 84% of the total return of the S&P 500 came from reinvested dividends, according to Hartford Funds. according to Hartford. Investors should keep that sort of performance in mind when choosing between a high- and low-dividend investment, and when choosing whether or not to reinvest dividends.