Calculating Index Value
Let’s continue with the same examples that we used in the previous articles. We started out by creating an index for the Indian IT sector. We then learnt about market cap and shares outstanding. We then learnt about which stocks can be included in an index. We also discussed weightage of stock in an index/basket and how due to price change weights keep changing but absolute number of shares remain the same.
We also considered another example of buying a basket where Rs.5000 was invested in 5 stocks. We saw how the number of shares purchased were calculated and how the total value of investment changed due to change in stock price. On the day of investment, value of the total investment was Rs 5000. Next day, the value changed to Rs 6050 and the day after that, it changed to Rs 7100. In this post, let’s try to understand how the final Index value is calculated and how it should be interpreted.
While calculating an index value, we want to see how investment value has been moving on a daily basis compared to the base value. In our example the base value is Rs 5000 and we want to understand how much returns we have earned on this amount. If we change the scale and say that 5000 = 100, then 6050 would be (100/5000)*6050. This is basic unitary mathematics. The below table summarizes the calculation of Index values for subsequent days, when we change the initial base value to 100 from 5000.
|Day||Investment Value||Index Calculation||Index Value|
|Investment Day + 1||6050||(100/5000)*6050||121|
|Investment Day + 2||7100||(100/5000)*7100||142|
Now we are clear about how an index is created, calculated and interpreted. Whenever creating an index, fix the initial value to a base number and then track progress of the investment by comparing it to the base value. Sensex has a base value of 100, fixed in 1978-79 and now it has increased to more than 25000. Similarly, Nifty has a base value of 1000, fixed on 3rd Nov’95 and has crossed more than 7500. You can easily calculate the returns that both the indices have generated, since their inception. On day one our Index value was 100 and on day two it increased to 121. Hence one day index return was 21% which can be verified by the following calculation (6050-5000)/5000 = 21%. At the end of day two our index value stood at 142 and this allows us to understand that we have made 42% returns over the previous two days. This can also be verified by the following calculation (7100-5000)/5000 = 42%.
It is prudent to create an index for your investments. Index creation allows one to easily understand returns and follow & track investments. Smallcase platform makes available easily trackable custom indices for your portfolio/investment. It’s time you upgrade the way you invest.