Tracking Difference Calculator

Index funds are compared on their management fee because it is the number everyone publishes, and it is not the number that determines what the fund costs you. A fund's job is to deliver its index, and the honest measure of its cost is how far short of that index it actually landed. That shortfall is the tracking difference, and it is almost always larger than the fee, because the fee is only one of several things standing between the index and your return. Trading costs when the index rebalances, cash held back for redemptions that earns nothing, sampling where a fund holds a subset of constituents rather than all of them, foreign withholding tax on dividends that cannot be fully recovered, and the spread paid on every purchase all reduce the return and none of them appear in a fee table. Occasionally the effect runs the other way, because revenue from lending the fund's securities can offset part of the cost, and a fund that beats its index after fees is doing so for a reason worth understanding. This page separates the two figures. It takes the fund's return and its index's return over the same period, works out the total cost of ownership, and shows how much of it the published fee actually explains. Then it does the same for a second fund, which is where the exercise usually pays for itself: the fund with the lower fee frequently has the larger shortfall, and picking on the advertised number picks the more expensive product.

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The Fee Is Not The Cost

An index fund exists to deliver its index. Whatever it fails to deliver is what it cost you, regardless of which line item the money went to.

On the worked example the fund charges 0.30% and landed 0.45% behind its index. The real cost is 1.50x the advertised one, and the extra 0.15% is $75.00 a year on $50,000.00 that appears in no comparison table anywhere.

Worked Example: Two Funds, One Index

The index returned 9.20%.

Fund A charges 0.30% and returned 8.75%, a shortfall of 0.45%. The fee explains two thirds of it.

Fund B charges 0.20% and returned 8.60%, a shortfall of 0.60%. The fee explains a third of it, so the real cost is 3.00x the stated one.

Fund B wins the fee comparison by 0.10% and loses the cost comparison by 0.15%. Over twenty years on $50,000.00 that is $4,940.93.

Where The Rest Of The Money Goes

Five things sit between an index and a fund's return, and only one of them is the fee.

Trading costs. Indices change their constituents, and every change forces the fund to trade. Those costs come out of the return.

Cash drag. A fund holding cash for redemptions has money not earning the index return.

Sampling. Funds tracking broad indices often hold a representative subset rather than every constituent, which is cheaper to run and does not track perfectly.

Withholding tax. Foreign dividends can be taxed at source in ways the fund cannot fully recover, and the index calculation may assume a recovery the fund does not get.

Spreads. Every purchase and sale crosses a bid-ask spread that no fee statement shows.

Sometimes It Runs The Other Way

A tracking difference smaller than the fee is not an error. It means the fund is recovering costs somewhere, usually by lending out its securities and keeping part of the revenue, or through a tax position better than the index assumes.

A fund that consistently beats its index after fees is worth understanding rather than distrusting. Securities lending carries counterparty risk that is generally small and is not zero, and the disclosure is in the fund documents.

Either way it is measurable, which is more than can be said for a fee comparison.

Difference Is Not Error

Two terms get used interchangeably and mean different things.

Tracking difference is the average gap between the fund and the index. It is a cost, it is persistent, and it is what this page measures.

Tracking error is how much that gap moves about from period to period. It measures consistency, not cost. A fund can have a large tracking error and cost you nothing on average, or a tiny tracking error while reliably costing 0.60% a year.

If you are choosing a fund to hold for decades, the difference is the one that matters.

How To Use This Properly

Run it on the one, three and five year figures separately rather than on one period. A single year contains a lot of randomness from the timing of index changes and money flowing in and out.

Check that the index named on the factsheet is the one the fund actually tracks, in the same currency and on the same hedged or unhedged basis. Comparing an unhedged fund against a hedged index measures the exchange rate, not the fund, and our currency hedged vs unhedged calculator shows how large that effect can be.

Then use the real cost figure everywhere you would have used the fee. Our fund fee drag calculator and one fund vs multi-fund calculator both become considerably more accurate once the number going into them is the true one.

Related NZ Fund Cost Calculators

• Fund Fee Drag Calculator: what a cost difference does over a long horizon.
• One Fund vs Multi-Fund Calculator: blended cost across several funds.
• Index Concentration Calculator: what the index itself actually holds.
• Currency Hedged vs Unhedged Calculator: making sure you compare like with like.
• Fund Overlap Calculator: whether two funds do the same job.