Why is my fund's return different from the index?Some background helps

Fees, taxes, timing, and which version of the index you were shown. All four are ordinary and all four are findable.

A tracker fund is supposed to do what the index does, and it never does exactly. The gap has a name — tracking difference — and a short list of causes, none of them mysterious.

Which version of the index am I comparing against?

Start here, because it is the single commonest cause of a confusing comparison. An index is published in several versions.

• Price return: the prices only. Dividends are ignored.
• Net total return: dividends reinvested, after a standard assumed withholding tax.
• Gross total return: dividends reinvested, no tax deducted.

The number quoted in the news is usually the price return. The fund is trying to match a total return version. On a broad index the difference is around 2% a year — far larger than any fee. A fund "beating the index by 2%" is very often just being compared to the wrong one.

How much do the fees take?

Exactly what they say, and steadily. A fund charging 0.20% a year will, all else equal, come in about 0.20% a year below its index. This is the one component that is fully predictable, and it is subtracted daily from the price rather than billed to you.

It is also why a fund can never quite match its benchmark: the index has no costs, and the fund does. What fees compound to over decades is on its own page.

Why does tax show up in a tracker?

When a fund holds foreign shares, the country the company sits in usually takes a slice of the dividend before it leaves. How much depends on the treaty between that country and where the fund is based. A fund domiciled in Ireland typically loses 15% of US dividends; one domiciled elsewhere may lose 30%.

Two funds tracking the identical index, holding identical shares, can therefore return different amounts purely because of where the paperwork lives. It is one of the few places where the wrapper genuinely changes the outcome, and the factsheet playbook shows where to find it.

What are cash drag and rebalancing costs?

An index is a list, and lists do not have to trade. A fund does. When dividends arrive they sit as cash for a few days before being reinvested; while they sit, they are not in the market. When the index changes its members, the fund has to buy and sell, and pays the spread and any tax on the way.

Both are small — a few basis points a year for a broad, liquid index. Both get larger for indices that change often, or that hold things which are expensive to trade.

Why is my personal return different from the fund's published return?

Because the fund's number assumes you bought at the start of the period and did nothing. If you paid in monthly, your money was not all invested for the whole period, so you earned the return of the months you were actually in.

This is not tracking error. It is the difference between what an investment returned and what an investor returned, and it is usually larger than everything above put together. How to read any market number is about exactly these traps.

How do I check whether a fund is tracking well?

Compare the fund's total return with the correct index version, over the same period, over several years. Consistent small underperformance roughly equal to the fee is a fund doing its job. Erratic gaps in both directions mean something else is going on, and that is worth understanding before adding money.