What Exactly is Tracking Error in Mutual Fund

I talked about the Index Fund and how the Index Fund tracks the underlying Index be it Nifty 50, Sensex or Nasdaq. Now in simple terms if the any of the Index is moving up, your Index fund will move up or vice versa. But does it always move up or down with the same percentage as that of the Index. Not really, this is because of the Tracking Error.

PC: Pixabay.com

Tracking error is a deviation which indicates how consistent your Index fund is with the underlying Index. That's means how closely it can track the underlying Index. If the tracking error is high that means there is a high deviation whereas if the tracking error is low than the deviation is low.

How tracking error effects the investors. Now the main reason for investing in the Index Fund is to make sure we are tracking the underlying Index and thuswith tracking error it deviates. So as an investor what we need to make sure before investing in any Index fund is how low is the tracking error and thus it helps us in the long run.

These are some of the tracking error of the Large and Mid Cap funds.

PC: CafeMutual.com

If you see the tracking error of Mid Cap and Small Cap will always be higher than the Large Cap. Because in large cap is it obvious that which 50 shares are there in Nifty 50 but with Mid Cap and Small Cap it usually changes at each trading day and thus the tracking error is higher. But it's still better because tracking error doesn't mean you are losing a lot of money, and it can also happen thar you might be benefitting with it. So I feel it's always better to go with the Index fund with less tracking error actually which holds a record of low tracking error for tye past year or so and invest in that.

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