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Lesson 4 of 10 · 13 min
What an index is: value, price return and total return
An index is a paper portfolio that stands for a market; its price return version tracks only price changes, while its total return version also reinvests every dividend and coupon, so it pulls further ahead over time.
In short
- A security market index represents a security market, a market segment or an asset class. Most are built as portfolios of marketable securities, the constituent securities.
- Index value = sum of (units held × price) ÷ a divisor. The divisor sets a convenient starting value and is adjusted so that events unrelated to price moves do not change the index.
- A price return index reflects prices only; a total return index also reflects the reinvestment of all income since inception.
- Single-period index return = change in index value (plus income, for total return) ÷ beginning value, or equivalently the weighted average of the constituents' returns.
- Over many periods, returns are linked geometrically: .
- Both versions start at the same value; the total return version then exceeds the price return version by a growing amount.
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