Tracking difference
The gap between a fund’s actual return and the return of the index it tracks over a given period, showing the real cost of tracking.
Tracking difference is the fund’s return minus the index’s return over a period such as a calendar year. For most index funds it is negative, because the fund pays costs that the index, a paper calculation, does not. The expense ratio is usually the largest contributor, but trading costs, cash drag from uninvested money and differences in dividend taxation also play a part. It can be smaller than the expense ratio, or even positive, when the fund earns income from lending its securities or pays less withholding tax on dividends than the index assumes.
For an investor choosing between funds that track the same index, tracking difference is often a better measure of true cost than the expense ratio alone, because it captures everything that happened inside the fund. Look at it over several years rather than one, since a single year can be flattered or hurt by one-off effects. Do not confuse it with tracking error, which measures how much the gap varies from period to period, not how large it is on average.
General education, not personal financial, tax or legal advice.