InvestmentFinancial Glossary
Tracking Error
Definition
The deviation between an index fund's returns and its benchmark index's returns, expressed as an annualized standard deviation. A tracking error of 0.1% means the fund closely mirrors the index. Higher tracking error indicates the fund is not efficiently replicating the index.
Why It Matters
When choosing between index funds tracking the same benchmark, lower tracking error is better — it means you are getting returns closer to the actual index return. Tracking error depends on the fund's expense ratio, cash holdings, and rebalancing efficiency. The best Nifty 50 index funds have tracking errors below 0.05%.