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Market Intelligence › Basic Terminologies
The difference between tracking error and tracking difference, and their causes
Published by The Retail Trader · AUG 04, 2026 · Mutual Funds & AMC
An index fund's job is to copy the index, but it can never copy it exactly. That gap has two names, and the two measure different things.
Tracking difference is the direct gap that shows up between the fund's return and the index's return over a period. It is usually negative, because costs fall on the fund, not on the index.
Tracking error measures the consistency of that gap. A low tracking error means the fund follows the index in a steady, uniform way.
These four causes are the most common:
• The expense ratio is deducted from the NAV every day.
• The fund has to hold a little cash for redemptions, which is not in the index.
• On index rebalancing days, trading has its own cost.
• Dividends reaching the fund and being reinvested is not instant.
Between two index funds that follow the same index, the choice comes down to TER and tracking record — because their portfolios are almost the same. Looking at "past return" is of little use here; looking at consistency is of more use.
This article is for educational purposes only — it is not a buy or sell recommendation, makes no guaranteed-return claim, and is not advisory. Rules, rates and mechanics are changed from time to time by the exchanges, SEBI and RBI, so verify every number yourself with your broker or an official source.