Loading the player...

What is a 'Drawdown'

A drawdown is the peak-to-trough decline during a specific recorded period of an investment, fund or commodity security. A drawdown is usually quoted as the percentage between the peak and the subsequent trough. Those tracking the entity measure from the time a retrenchment begins to when it reaches a new high.

BREAKING DOWN 'Drawdown'

This drawdown method of recording is useful because a valley can't be measured until a new high occurs. Once the investment, fund or commodity reaches a new high, the tracker records the percentage change from the old high to the smallest trough. Drawdowns help determine an investment's financial risk. Both the Calmar and Sterling ratios use this metric to compare a security's possible reward to its risk.

Drawdown is simply the negative half of standard deviation in relation to a stock’s share price. A drawdown from a share price’s high to its low is considered its drawdown amount.

Stock Drawdowns

A stock’s total volatility is measured by its standard deviation, yet many investors, especially retirees who are withdrawing funds from pensions and retirement accounts, are concerned about drawdowns. During volatile markets, and markets that have a possibility of a correction, drawdown is a serious concern for retirees. Many are starting to look at the drawdown of their investments, from stocks to mutual funds, and considering their possible maximum drawdown (MDD) potential.

Drawdown Risk

Drawdowns present a significant risk to investors when considering the uptick in share price needed to overcome a drawdown. For example, it may not seem like much if a stock loses 1%, as it only needs an increase of 1.01% to recover to its previously held position. However, a drawdown of 20% requires a 25% return, while a 50% drawdown – seen during the 2008 to 2009 Great Recession – requires a whopping 100% increase to recover the same position. Most investors want to avoid drawdowns of 20% or greater before cutting their losses and turning a position into cash investments.

Retirees, in particular, feel this risk, if they are doubling down on the drawdown economics as they withdraw further funds from the principal of their investments to fund their retirements. In many cases, a drastic drawdown, coupled with continued withdrawals in retirement can shorten retirement funds considerably.

Drawdown Assessments

Typically, drawdown risks are mitigated by having a well-diversified portfolio and knowing the length of the recovery window. If a person is early in his career or has more than 10 years until retirement, the drawdown limit of 20% that most financial advisors expound should be sufficient to shelter portfolios for a recovery. However, retirees need to be especially careful about drawdown risks in their portfolios. Diversifying a portfolio across stocks, bonds and cash instruments can offer some protection against a drawdown, as market conditions affect different classes of investments in different ways.

Stock price or market drawdown should not be confused with retirement drawdown, which refers to how retirees should withdraw funds from their pension or retirement accounts.

RELATED TERMS
  1. Drawdown Percentage

    A drawdown percentage is the portion of a retirement account ...
  2. Maximum Drawdown (MDD)

    A maximum drawdown (MDD) is the maximum loss from a peak to a ...
  3. Fixed Amortization Method

    The fixed amortization method spreads retirees’ account balances ...
  4. Ulcer Index - UI

    Ulcer Index is a technical indicator that measures downside risk, ...
  5. Risk Management

    Risk management occurs anytime an investor or fund manager analyzes ...
  6. Four Percent Rule

    The 4 percent rule is one way for retirees to determine the amount ...
Related Articles
  1. Trading

    An Introduction to Managed Futures

    Their inverse correlation with stocks and bonds make these investments worth getting to know.
  2. Investing

    3 Long-Term Investing Strategies With Strong Track Records

    Learn why discipline and a statistically valid investment strategy can help an investor limit losses and beat the market over the long term.
  3. Investing

    Should Your Retirement Portfolio Include Alternative Investments?

    Alternative investments have the potential to generate attractive returns with the added benefit of protecting a portfolio from market volatility.
  4. Retirement

    6 Ways To Calculate How Fast You'll Run Out Of Retirement Funds

    One of the key aspects of retirement planning is determining the amount of time that it will take for you to exhaust your retirement savings.
  5. Investing

    Diversify Your Strategies, Not Your Assets

    Find out how to achieve true portfolio diversification where the benefits are real and pro­vide tangible results. Learn how to identify return drivers.
  6. Investing

    Interpreting a Strategy Performance Report

    A strategy performance report can provide key metrics to decide if your strategy is a winner.
  7. Investing

    Goldman Sachs See Short-Term Pull Back in Stocks (GS)

    Goldman Sachs' research article suggests some short-term volatility before market stabilization into year end.
  8. Financial Advisor

    Best Income Investing Strategies for Retirees

    The past few years have been tough for retirees seeking income from their investments. Here are some of the best strategies that can help.
  9. Retirement

    The Magic Age of 59½

    At age 59½ you can withdraw from IRAs or borrow from your 401(k) without paying a penalty. You will owe income tax on all but Roth funds, however.
Hot Definitions
  1. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  2. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  3. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  4. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  5. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  6. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
Trading Center