What is a Performance-Based Index?
A performance-based index is a stock index which adds to the net stock price the amount of all the dividend payments, capital gains, and other cash disbursements. Before calculating the index return, the performance-based index will add those transactions to the net share price when measuring the performance over a given period.
A non-performance index, by contrast, calculates returns on weighted market value without regard for cash disbursements, such as the S&P 500. Some investors conclude that a performance-based measurement provides a more reliable performance indicator than the approach to prices.
Breaking Down Performance-Based Index
An index based on performance differs from a price index in that performance is equal to the sum of corporate events and price movement. In contrast, a price index considers a security's capital gains or losses without regard to cash disbursements, such as dividend payments.
The bulk of US stock indices were based on a price index. Yet, a performance-based calculation like the German stock market index DAX has been adopted by many significant Europeans. Thus, the DAX, a benchmark of 30 blue-chip companies in Germany, quotes the price of reinvested dividends. This can make investors confused when comparing headline prices between different countries.
It's essential to compare portfolio returns with the performance-based version of an index to see an excellent one-to-one contrast. A total return index will always appear higher than the price return index because it contains additional factors that cannot turn negative.
Tracking the price return index is fine, but it is a good idea to use the total return index when measuring or comparing portfolio returns with an index.
