What is tracking error in an index fund?

Tracking error measures how closely a fund follows the index it's supposed to mirror — the gap between the fund's return and the benchmark's return. A pure S&P 500 index fund aims to match the index, but it can drift slightly because of fees, the cash it holds, the timing of trades, and how it handles dividends. The biggest source is the expense ratio: a fund charging 0.50% will trail its index by roughly that much every year, while a 0.03% fund stays almost glued to it. Low tracking error is what you want from an index fund — you're paying it to deliver the market, not to wander. When comparing two funds tracking the same index, the cheaper one almost always has lower tracking error. It's one more reason to favor rock-bottom expense ratios.