# Tracking Error and Tracking Risk

Tracking error is a measure of how closely a portfolio follows its benchmark. A tracking error of zero means that the portfolio exactly follows its benchmark. The benchmark could be an index such as S&P 500 index. Let’s say the S&P 500 index provides a return of 6% and your portfolio tracking the S&P 500 index earns 4% returns. The tracking error is calculated as follows:

In our example, the tracking error will be:

**Tracking error = 4% - 6% = -2%**

Morningstar defines tracking error as trailing returns.

**Tracking Risk:** Tracking error sometimes also refers to tracking risk, which is the standard deviation of returns of the portfolio to benchmark returns over a period of time. This is a more commonly used method of calculating tracking error.

Tracking error is an important measure for investors to know how well the portfolio is replicating the index. A low tracking error indicates the portfolio is closely following the benchmark. A high tracking error means the portfolio is moving away from the benchmark index. Investors desire a low tracking error.

- What is a Probability Distribution
- Discrete Vs. Continuous Random Variable
- Cumulative Distribution Function
- Discrete Uniform Random Variable
- Bernoulli and Binomial Distribution
- Stock Price Movement Using a Binomial Tree
- Tracking Error and Tracking Risk
- Continuous Uniform Distribution
- Normal Distribution
- Univariate Vs. Multivariate Distribution
- Confidence Intervals for a Normal Distribution
- Standard Normal Distribution
- Calculating Probabilities Using Standard Normal Distribution
- Shortfall Risk
- Safety-first Ratio
- Lognormal Distribution and Stock Prices
- Discretely Compounded Rate of Return
- Continuously Compounded Rate of Return
- Option Pricing Using Monte Carlo Simulation
- Historical Simulation Vs Monte Carlo Simulation

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