Tracking Error — Mutual Fund Term Explained

For index funds: how closely the fund tracks its benchmark. Lower is better — high tracking error means the fund deviates from the index.

Tracking error measures the standard deviation of the difference between a fund's returns and its benchmark's returns. For index funds and ETFs, this is the primary quality metric.

A good Nifty 50 index fund should have tracking error below 0.1% per year.

Formula

Tracking Error = Standard Deviation of (Fund Return − Index Return)

Related terms

• Benchmark — The market index a fund is compared against. A fund manager must beat the benchmark consistently to justify active management fees.
• Index Fund — A passively managed fund replicating a market index like Nifty 50. Ultra-low cost (0.05%). Most active funds underperform over 10+ years.
• ETF (Exchange Traded Fund) — Like an index fund but traded on a stock exchange at real-time prices. Requires a demat account. Slightly cheaper than index funds.
• Expense Ratio — The annual fee charged by a mutual fund as a % of AUM. Covers management fees, operational costs and commissions. Deducted daily from NAV.

Browse the full mutual fund glossary, or see this concept in action in the fund screener.