What Is Mutual Fund R-Squared?
Definition & Examples of Mutual Fund R-Squared
R-squared in mutual funds is a statistical tool that investors can use to compare a fund to a given benchmark. A higher R-squared value means the fund moves with the benchmark. This allows investors to monitor investments and maintain a more diversified portfolio.
Learn more about how a mutual fund's R-squared works and whether you should consider it before investing.
What Is Mutual Fund R-Squared?
One of the most basic measuring tools for a complete analysis of mutual funds is called R-squared. This is a statistical measure that investors can use it to determine a particular fund's similarity to a given benchmark.
R-squared does not measure the performance of a mutual fund or of your portfolio, Instead, it compares your portfolio's returns to a benchmark and expresses that comparison as a percentage between one and 100.
The higher the percentage, the more your portfolio mirrors the benchmark. An R-squared of 100% indicates that the movement of your portfolio is entirely explained by the movement of the benchmark.
How Mutual Fund R-Squared Works
When you're considering whether to invest in a mutual fund, it's important to understand not only how it performs, but also how it fits in your entire portfolio.
R-squared can help you choose the best funds by planning the diversification of your portfolio.
For example, if you already hold an S&P 500 mutual fund or another fund with a high R2 compared to the S&P 500, you will want to find a fund with a lower correlation (lower R2). Holding both types of funds will help you build a portfolio of diversified mutual funds.
In general, R-squared values are divided into three tiers:
- 1–40%: low correlation to the benchmark
- 40%–70%: average correlation to the benchmark
- 70%–100%: high correlation to the benchmark
If an actively-managed mutual fund has an R-squared value over 85%, you will pay less if you simply buy into an index fund that parallels the benchmark, rather than paying high fees for a professionally-managed fund that does the same thing.
R-squared can also be useful for reviewing existing funds in a portfolio to be sure their style has not "drifted" toward that of the benchmark. If any funds are too close or too far away from their original benchmarks, you can sell and buy into funds that maintain your original portfolio diversification.
Do I Need to Use Mutual Fund R-Squared?
R-squared is a useful tool for diversification purposes. It can be used to check the performance of different assets in your portfolio and decide whether you want to keep them or not.
However, you can also achieve diversification through the funds you choose to buy. The simple practice of making sure the funds in your portfolio represent different types of mutual fund categories is usually enough to build a diversified portfolio of mutual funds. Building a portfolio around hybrid funds can also help you diversify while meeting (or diverging from) prominent benchmarks.
R2 can provide a useful basis for comparison, but it's not an essential metric if you or your advisor have other ways of ensuring that you maintain a portfolio of diversified investments.
- R-squared, or R2, in mutual funds, is a statistical benchmark that investors can use to compare a fund to a given benchmark.
- R-squared values are expressed as a percentage between 1 and 100. A higher R-squared value means the fund moves with the benchmark.
- Knowing a fund's R2 allows investors to maintain a more diversified portfolio by ensuring that their investments don't all correlate to the same benchmarks.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.