Stock Market Indices Accumulation Indices

When looking at the stock market today, we are highly likely to hear of the change in the broad price indices, probably the ‘All Ordinaries’ price index or the ‘S&P/ASX 200’ price index.

It is important to understand that these indices measure only price change. That means that they are measuring the capital gain or loss over a given period, forming all that speculators and other short term traders are primarily concerned about.

However, investing is quite different to speculating. Speculating is concerned with profit from short term price changes in stocks. On the other hand, investing is concerned with total return from stocks.

Total return is the net sum of dividends, imputed (or franking) credits and capital growth or decline over a period of time and frequently for a total portfolio of stocks.

For investors, the best measure that we have of total return is known as the accumulation index. It is also appropriately called the total return index by Standard and Poors, who calculate it for the ASX. Most private investors will not have heard of the accumulation indices and if they have, they will tend not to know what it is.

The difference between the price index and the accumulation index is simple - the accumulation index is the price index adjusted for the notional reinvestment of dividends as from the date each stock in the index is quoted on the ASX as ex-dividend. This is the date from which a buyer of the stock is not entitled to the latest dividend.

Thus, the accumulation index is the best index we have to measure total investment return from stocks. The accumulation index is a good tool used by investors for assessing how their portfolio has performed relative to the general market.

However, accumulation indices are not perfect. They have two problems. Firstly, accumulation indices do not include imputed credits, probably because it is too difficult. Secondly, dividends cannot be reinvested until they are paid, which can be several weeks after the ex-dividend date. This means that accumulation indices will overstate return in respect of dividend reinvestment, but understate it in terms of the extent to which imputed credits are refunded to and reinvested by investors with low of zero tax rates.

That being said the accumulation indices are the best tool we have for assessing relative stock portfolio returns.

Colin Nicholson’s books: Building Wealth in the Stock Market and The Psychology of Investing may be purchased from Colin’s website www.bwts.com.au and good bookstores). Contact Colin at colin@bwts.com.au or through his web site where you may join the list to receive his free email newsletter.

Copyright Colin Nicholson colin@bwts.com.au. Do not reproduce without permission.