Drawdown
In short
#FinanceDrawdown is the fall from a portfolio's peak value to its lowest point before a new peak is reached, expressed as a percentage. Maximum drawdown is the worst such fall over a period.
Why it matters
Drawdown is the number that actually determines whether someone stays invested, which makes it more useful than annual return for judging a strategy. It is also brutally asymmetric: a 50% drawdown needs a 100% gain to recover, and a 20% drawdown needs 25%.
Example
A portfolio rises to $120,000, falls to $84,000, then recovers. The maximum drawdown is 30%, and getting back to $120,000 from the low requires a gain of about 43%.
Frequently asked
Why does recovering from a drawdown need a bigger percentage gain?
Because the gain is calculated on a smaller base. Losing 30% of $100 leaves $70, and returning to $100 from $70 is a 43% gain. The deeper the loss, the more punishing the asymmetry.
Is drawdown more useful than volatility?
For most individuals, yes. Volatility counts moves in both directions, while drawdown measures the loss you actually had to sit through, which is what determines whether a plan survives contact with a bad year.