Glossary term
R-Squared (R²)
R-squared is a statistical measure that shows how much of one investment's movement is explained by movement in a benchmark or another variable.
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What Is R-Squared?
R-squared is a statistical measure that shows how much of one investment's movement is explained by movement in a benchmark or another variable. In investing, it is often used to see how closely a fund or portfolio tracks a benchmark.
R-squared is usually shown as a percentage from 0 to 100. A higher number means the benchmark explains more of the investment's movements. A lower number means the investment behaves less like the benchmark.
Key Takeaways
- R-squared measures how much movement is explained by a benchmark or variable.
- A high R-squared can mean a fund behaves very similarly to its benchmark.
- A low R-squared can mean the benchmark is a poor comparison or the fund is taking different exposures.
- R-squared does not tell investors whether returns are good or bad.
- It should be read alongside beta, alpha, tracking error, holdings, fees, and investment objective.
How R-Squared Works
If a fund has an R-squared of 95 relative to an index, most of the fund's historical movement has been explained by that index. If the R-squared is 40, the index explains much less of the movement.
That can help investors decide whether a benchmark is appropriate. It can also reveal whether an active fund is behaving like a closet index fund or taking meaningfully different exposures.
How to Read R-Squared
R-squared level | Possible interpretation |
|---|---|
High | Investment has moved closely with the benchmark |
Moderate | Benchmark explains some movement, but not all |
Low | Benchmark may be a poor fit or the investment has different drivers |
Limits of R-Squared
R-squared is backward-looking and depends on the benchmark chosen. A high number does not mean the investment is safe, cheap, or well managed. A low number does not automatically mean the investment is bad.
The measure is best used to understand fit and comparison, not to make a buy or sell decision by itself.
The Bottom Line
R-squared shows how much of an investment's movement is explained by a benchmark or another variable. It is useful for evaluating benchmark fit, but it does not measure investment quality on its own.