Tracking Error

By Greg Parsons, editor

Educational only, not financial advice.

Tracking error is the difference between how an index fund or ETF performs and how the index it’s trying to follow performs.

Why it matters

• Index funds and ETFs are designed to match, not beat, their benchmark index.
• Lower tracking error means the fund is doing a better job of staying close to the index.
• High or inconsistent tracking error can make your portfolio behave differently than you expect.

Why tracking error happens

• Fees: MER and trading costs reduce returns vs. the index.
• Sampling: Some funds hold only a subset of index holdings.
• Cash drag: Funds may hold some cash, especially when receiving inflows or outflows.
• Rebalancing & timing: Differences in when the fund adjusts its holdings compared with the index.

Simple example

If an index returns 8% in a year but the ETF that tracks it returns 7.6%, the 0.4 percentage-point gap is largely tracking error (including the MER and other frictions).

Related terms

• MER (Management Expense Ratio)
• Diversification
• Volatility

Learn more

• Investing Education Hub
• Investment Calculators