What is tracking error in ETFs?

Tracking error measures how closely an ETF follows its benchmark index. Even if an ETF is designed to track an index, real-world frictions like fees, rebalancing, cash drag, and trading costs can cause deviations.

Some deviation is normal. The important question is whether the ETF consistently lags the index more than expected (tracking difference) or behaves unpredictably versus the benchmark.

If you're choosing between two similar index ETFs, look at long-run tracking difference, fund size, and liquidity. A slightly higher fee can sometimes be worth it if the ETF tracks better and trades more efficiently.