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R-squared

What is R-squared?

R-squared measures the relationship between a portfolio and its benchmark index. It is expressed as a percentage from 1 to 100. R-squared is not a measure of the performance of a portfolio. Rather, it measures the correlation of the portfolio's returns to the benchmark's returns.

If you want a portfolio that moves like the benchmark, you'd want a portfolio with a high R-squared. An R-squared of 100 indicates that all movements of a portfolio can be explained by movements in the benchmark. For example, an index fund that tracks the S&P 500 invests in the same stocks in the same proportions as the index; therefore, its R-squared relative to the S&P 500 Index is very close to 100.

If you want a portfolio that doesn't move at all like the benchmark, you'd want a low R-squared. An R-squared measure of 35, for example, means that only 35% of the portfolio's movements can be explained by movements in the benchmark index.

General range for R-squared:

70-100% = high correlation between the portfolio's returns and the benchmark's returns

40-70% = average correlation between the portfolio's returns and the benchmark's returns

1-40% = low correlation between the portfolio's returns and the benchmark's returns

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