Rather than focusing on returns, consider tracking errors for Index Funds.

Investing in Index Funds There are numerous advantages to passive investing, which are funds in which the manager makes no active decisions. They will generate market-related returns (i.e., they will not lag behind the benchmark index) and have lower expenses than actively managed funds.

4 min readMar 7, 2022


The key distinction between a market index and a fund like this is the cost of operation. A modest quantity of cash may also be present in the fund to aid in the management of withdrawals. Index funds have been improving their performance in this regard over time.

To be sure, passive fund performance isn’t measured in the same way that active funds are. We don’t pay attention to how much money they earn. It’s known as the tracking error, and it reveals how far the returns differed from the benchmark index, which is what we’re interested in.

The returns of these funds should, in theory, be the same as the returns of the underlying index, but due to costs and cash equivalents, they may be somewhat lower, such as 99.9%. Clearly, the lower the tracking error, the better.

The annualize standard deviation of the difference in returns between an index fund and its corresponding index is known as the annualize standard deviation of the difference in returns between an index fund and its corresponding index.

An index fund management must determine how effectively they are tracking each day, particularly if the fund is open-ended. The tracking error is calculated using the total returns index (TRI), which includes dividends and indicates the returns on the index portfolio. The total returns on the index portfolio, including the dividend, are shown in the TRI.

Error tracking has improved.

Let’s get to the data, which is our next stop. Until January 2022, 11 index funds were following the Nifty50 for one, three, and five years. Over that time period, we looked at the tracking inaccuracy of that group of funds.

Over the last five years, the average was 0.78 percent, and over the last three years, it was 0.95 percent. The tracking inaccuracy dropped dramatically to 0.33 percent over the course of a year.

As this calculation demonstrates, a tracking error of 0.95 percent does not imply that the index fund’s returns are significantly lower than the Nifty’s. It’s simply the result of a process established by the National Stock Exchange to figure out how the system works.

This metric’s output increased by 0.13 percent in the three months ending in January 2022, indicating that even more progress has been made.

Index funds, at least those that track the Nifty, have improved their performance over time. At the risk of redundancy, “performance” here refers to how rapidly you can track the index rather than how much money you make.

UTI Nifty Index Fund, HDFC Index Fund Nifty 50, and SBI Nifty Index Fund are the three funds that are most efficient over five, three, and one years.

As I previously stated, the last three months have seen much more growth. The finest index funds include Navi Nifty 50 Index Fund, UTI Nifty Index Fund, SBI Nifty Index Fund, and HDFC Index Fund Nifty 50.

To put it another way, how has efficiency improved? Expense ratios are decreasing since there is increasing competition among passive funds. The advantage, on the other hand, is going to investors.

Navi Mutual Fund revolutionized the game by reducing fund management costs, and other MFs are following suit.

Despite the fact that it is a new company, Navi has quickly risen to the top. Since November 2021, it has improved its tracking inaccuracy, which has been made easy by very low fund recurring charges. This, as far as I’m aware, will continue to be the case in the future.

ETF tracking errors aren’t the same as ETF tracking errors.

Exchange-traded funds (ETFs) have tracking errors as well, but there is one slight difference between them and index funds when this statistic is used to assess how well they track.

When you purchase and sell ETFs, you’re buying and selling them at their market value, which isn’t always the same as their net worth (NAV). The tracking error of ETFs is calculated using their NAVs, which are the day’s closing prices. This is the price at which the ETF was purchased or sold, not the price at which an investor purchased or sold units.

As a result, the estimated tracking error is simply a statistic that indicates how well the indexes are performing, but not how well investors are performing.

Everyone who buys an ETF will have a distinct tracking error, whereas everyone who buys an index fund will have the same tracking error because all units are issued at the same NAV on the same day.

Investors are in better shape than they were previously, thanks to advances in technology and lower fund operating expenses. Smart investors can evaluate index funds and make investing selections depending on how effectively they track the market.