Drawdown
Definition
Drawdown is the percentage decline in portfolio value from its latest peak. Maximum drawdown is the deepest such decline in the history of an investment.
Drawdown is the decline in a portfolio’s value from its highest level so far, expressed as a percentage. If the portfolio reached a peak and then fell 20%, the drawdown is 20%, and it lasts until the portfolio sets a new high.
Maximum drawdown (MDD) is the largest such decline in the period studied. It is one of the most intuitive risk measures: it shows how much you would have lost at the worst moment had you bought at the very top.
The math of recovering losses
- A 10% decline needs a gain of about 11% to get back to the peak.
- A 25% decline needs a 33% gain.
- A 50% decline needs a 100% gain.
That is why deep drawdowns are so costly: the bigger the fall, the disproportionately bigger the rise needed to recover. Besides depth, look at duration too: how many months or years the portfolio took to return to its peak.
Drawdown and deposits
A drawdown calculated from the portfolio value alone can mislead: a large deposit can hide a decline, and a withdrawal can look like a loss. A sound drawdown is calculated from the time-weighted return (TWR) curve, which removes the effect of deposits and withdrawals.
Related terms
All terms- Portfolio volatilityPortfolio volatility measures how much its returns swing. It is usually calculated as the standard deviation of daily, monthly or yearly returns.
- Sharpe ratioThe Sharpe ratio measures how much excess return over the risk-free rate a portfolio earns per unit of volatility. The higher it is, the better the risk was rewarded.
- TWRTWR is a time-weighted rate of return: it measures the investments alone, without the effect of deposits and withdrawals. It is the standard for benchmarking.