What it is
Tracking error quantifies the difference between the returns of an investment fund, such as an exchange-traded fund (ETF), and the returns of its target benchmark index or underlying asset over a specified period. A lower tracking error indicates that the fund is more accurately replicating the performance of its benchmark, while a higher error suggests a greater divergence.
Factors contributing to tracking error include the fund's expense ratio, transaction costs incurred from buying and selling assets, cash holdings that aren't fully invested, and differences in the fund's asset holdings compared to the index. Investors compare tracking errors when selecting ETFs, as it directly impacts how well the ETF delivers its promised exposure and returns.
Why it matters
A low tracking error ensures your ETF investment closely reflects the performance of the asset or index it's designed to track, preserving your intended returns.
Reviewed under editorial standardsUpdated September 26, 2026Not investment advice