What Is R-Squared?

We’re trying to learn more about mutual funds, which we find quite frightening, so let’s start by breaking down some terms, like R-squared, a measure of volatility. Here’s what Vanguard says:

R-squared measures how much a fund’s past returns can be explained by the returns from its benchmark index.

If a fund’s total returns were precisely synchronized with the index’s return, its R-squared would be 1.00 (100%). If a fund’s returns bore no relationship to the index’s returns, its R-squared would be 0.

The higher the R-squared, the more the fund’s return can be explained by the performance of the index, and so the performance of the market or market segment. The lower the R-squared, the more the return can be explained by the fund manager’s decisions.

So, no-load index funds, which we’re interested in, handled completely by computers, which attempt to sync with the performance of a benchmark index, like the S&P 500, should have an R-squared of 1. For example, the Vanguard 500 Index, whereas the “Vanguard Capital Value” fund seeking “companies that are out of favor with investors and that are trading at prices below what the stocks are worth compared to potential earnings” has an R-Squared of 50.88%.

(Don’t think we have a crush on Vanguard or anything, we just have an account there so that’s the easiest place to go for us for this information)

This is also referred to as the “coefficient of determination” and can be determined using scary Greek symbols.

Luckily for mere mortals, places like Google Finance figure out the R-squared for ya.

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