TER vs tracking difference: which number actually costs you money?

The total expense ratio is the fund's stated running cost: management fee, administration, custody. It is deducted from the fund's assets continuously rather than billed to you, which is why most investors never feel it.

What it leaves out matters. Transaction costs inside the fund, the drag from uninvested cash, and the withholding tax lost on foreign dividends are all real costs to you and none of them appear in the TER.

Tracking difference is the fund's return minus the index's return over a period. If the index returned 10.00% and the fund returned 9.82%, the tracking difference is −0.18%. That single number captures everything: the TER, the hidden costs, and anything the fund earned back.

Because managers can earn revenue from lending out the fund's shares, and because domicile changes how much dividend tax is recovered, a fund with a higher headline fee sometimes tracks its index more closely than a cheaper rival.

One year of tracking difference is noise. Look at three to five, from the same source, and check that you are comparing the same index — MSCI World and FTSE Developed are not interchangeable.

Then sanity-check the fund size. A very small fund with excellent tracking is still a fund that might be merged away, which forces a disposal at a time you did not choose.