What Is a Performance-Based Index?
A performance-based index is a stock index that adds the amount of all dividend payments, capital gains and other cash disbursements to the net stock price. When measuring the performance over a given time period, the performance-based index will add these transactions to the net share price before calculating the index return. A performance-based index differs from a price index in that performance equals the sum of corporate events and price movement. A performance-based index is a stock index that adds the amount of all dividend payments, capital gains and other cash disbursements to the net stock price. It is fine to track the price return index, but it is a good idea to use the total return index when measuring or comparing the returns of a portfolio with an index.
In contrast, a non-performance index calculates returns on weighted market value without regard for cash disbursements like the S&P 500. Some investors believe a performance-based calculation produces a more accurate measure of performance than the price approach.
Breaking Down Performance-Based Index
A performance-based index differs from a price index in that performance equals the sum of corporate events and price movement. A price index, on the other hand, considers capital gains or losses of a security without regard for cash disbursements like dividend payments. Most US stock indexes are calculated on a price index. However, many large European have adopted a performance-based calculation like the German stock market index DAX. Hence, the DAX, a benchmark of 30 blue-chip companies in Germany, quotes the price with dividends reinvested. This can confuse investors comparing headline prices between different countries.
For instance, the DAX could appear to outperform a non-performance index in a given year, but the truth is price returns of the German index may be aligned with the other markets. This can help explain why the DAX attained record highs in recent years compared to other European markets like the FTSE 100 and CAC 40.
To see a fair one-to-one contrast, it is important to compare portfolio returns with the performance-based version of an index. A total return index will always appear higher than the price return index as it includes additional factors that are incapable of turning negative. It is fine to track the price return index, but it is a good idea to use the total return index when measuring or comparing the returns of a portfolio with an index. This represents the total amount an investor would take home beyond just capital gains.
Benefits of a Performance-Based Index
Since a performance-based index incorporates all capital generating mechanisms, it provides investors with a more accurate depiction of performance. This may not be significant for the casual market observer, but an ardent investor requires a performance-based measure to manage risk and position sizing effectively. Many of the other benefits that come with a performance-based index replicate a total return index, including diversification and lower fees.
Related terms:
Capital Gain
Capital gain refers to an increase in a capital asset's value and is considered to be realized when the asset is sold. read more
DAX Stock Index
The DAX is a German blue chip stock market index that tracks the performance of the 30 largest companies trading on the Frankfurt Stock Exchange. read more
Dividend
A dividend is the distribution of some of a company's earnings to a class of its shareholders, as determined by the company's board of directors. read more
Dividend Yield
The dividend yield is a financial ratio that shows how much a company pays out in dividends each year relative to its stock price. read more
Indexing
Indexing may be a statistical measure for tracking economic data, a methodology for grouping a specific market segment, or an investment management strategy for passive investments. read more
Russell 2000 Index
The Russell 2000 index measures the performance of the 2,000 smaller stocks that are listed in the Russell 3000 Index. read more
Security Market Indicator Series (SMIS)
A security market indicator series (SMIS) uses the performance of a subset of securities to represent the performance of the broader market. read more
STOXX
STOXX is a leading provider of market indexes that are representative of European and global markets. read more
Total Return Index
Total return indexes include any dividends and interest payments in the calculation of its returns. read more
Value Added Monthly Index (VAMI)
A value added monthly index (VAMI) tracks the monthly performance of a hypothetical $1,000 investment, assuming reinvestment, over a period of time. read more