Investing term

What is Tracking error?

How far a passive fund's performance drifts from its stated index.

Tracking error measures how far a passive fund's performance drifts from the index it's meant to mirror. A good index fund keeps it minimal — its job is to match, not deviate. Persistent tracking error can come from fees, imperfect replication, or cash drag, and comparing it across similar funds helps you spot which one most faithfully (and cheaply) delivers the index.

For example

An index fund that returns 9.8% when its benchmark returned 10% has a 0.2% tracking error — small, and largely explained by its fee.

Tracking error is taught hands-on in Stage 6 — Index Funds, ETFs & Mutual Funds.

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Related terms

Active fundA fund whose manager picks stocks in the hope of beating a benchmark.BenchmarkThe reference index a fund compares itself to — e.g. the S&P 500, MSCI World, or Bloomberg Aggregate.Creation/redemptionThe mechanism that keeps ETF prices close to NAV. Authorized participants swap baskets of underlying stocks for ETF shares (or vice versa).DistributionThe income a fund pays out to its shareholders — dividends from stocks held, plus realized capital gains.
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