R-Squared (R²)
In short
How much of portfolio returns are explained by market movements (0-1)
R-squared tells you how much your portfolio moves in sync with the overall market. An R² of 0.95 means 95% of your portfolio's ups and downs are explained by the market. A low R² means your returns come from other factors — which can be good (alpha) or risky (concentrated bets).
R-squared (coefficient of determination) measures the proportion of a portfolio's return variance that is explained by its benchmark. It ranges from 0 to 1. A high R² (>0.85) means the portfolio closely tracks the benchmark, making beta and alpha more meaningful. A low R² suggests the portfolio has significant exposure to factors beyond the benchmark, and metrics like beta become less reliable as descriptors of risk.
Formula
R² = 1 - (SS_res / SS_tot)Thresholds
- >0.85
- Closely tracks market
- 0.60-0.85
- Moderate tracking
- <0.60
- Low market correlation
Related concepts
- Beta — Beta of 1.0 means the stock moves in line with the market. Beta of 1.5 means if the market rises 10%, this stock typically rises 15% — more volatile. Beta of 0.5 means less volatile than the market.
- Alpha — Alpha is the extra return a fund earns above what you'd expect given its risk. If the market returns 10% and your fund returns 13% with the same risk, alpha is 3%. Positive alpha = the manager adds value.
- Sharpe Ratio — Sharpe ratio measures how much return you get for every unit of risk you take. A Sharpe of 1.0 means for every 1% of risk, you earn 1% return above the risk-free rate. Higher is better.
- Portfolio Volatility — Portfolio volatility measures how much your combined investments bounce around. Unlike individual stock volatility, it accounts for diversification — when some holdings go up while others go down, they partially cancel out, reducing overall portfolio risk.