R-squared – or the coefficient of determination – is a statistical measure that represents the percentage of a fund or security's movements that can be explained by movements in a benchmark index. Ranging from 0 to 1, a higher r-squared value indicates a high degree of correlation between the investment and the benchmark.
For investors, r-squared is useful in determining how closely an investment follows the market or a particular benchmark. A high r-squared (close to 1) suggests that the investment's performance closely mirrors the benchmark, which can be important for index funds or when assessing how well a fund manager is tracking their benchmark.
While a useful indicator of correlation, r-squared does not measure the quality of an investment's performance. An investment can have a high r-squared but still underperform its benchmark. Additionally, a low r-squared may indicate a more active management style, which could be preferred by investors seeking diversification away from market indices.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.