Definition
Drawdown is the percentage decline in a portfolio's value from a prior peak to a subsequent trough, measuring how far the portfolio has fallen from its best previous level at any given point.
Why it matters
Drawdown is the risk measure that captures what an investor actually experiences during a decline: the gap between the value they had at the last high and the value they have now. Standard deviation summarizes typical variability around an average; drawdown names the specific downside event a participant lives through. It is the natural framing for sequence-of-returns risk in retirement, where a large drawdown early in the withdrawal phase permanently reduces the base from which future income is drawn.
How it works
A drawdown is measured at a given point in time as the percentage decline from the highest value the portfolio has previously reached to the current value. If a portfolio reaches a peak of one hundred, falls to eighty, and is currently sitting at eighty-five, the drawdown at that point is fifteen percent, measured against the prior peak of one hundred. Drawdowns are typically tracked continuously, with the drawdown series showing zero whenever the portfolio is at a new high and a positive number reflecting the decline from the last peak whenever it is below one. A drawdown is considered closed when the portfolio recovers to its prior peak; it remains open as long as the portfolio is below that peak. Worked example: an equity portfolio that fell from one hundred to fifty during a bear market and has since recovered to eighty sits in a twenty percent drawdown from the prior peak. It has recovered thirty points off the bottom but remains twenty percent below the level where the drawdown began.
In practice
For an individual evaluating investment options for retirement savings, drawdown is often the most decision-relevant risk measure because it describes the shape of decline rather than the shape of typical variability. Two funds with similar standard deviations can produce very different drawdown experiences depending on how the timing and clustering of their returns unfolds, which is what matters for a participant who happens to hold the fund through a specific bear market. A professional working on retirement decumulation planning examines historical drawdowns to stress-test withdrawal strategies, since a drawdown coincident with the first few years of income draws produces disproportionately damaging path effects on lifetime income. Plan fiduciaries reviewing default investment options should recognize that participants approaching or in retirement are especially exposed to drawdown-shaped risk.
Related terms
- Maximum drawdown
- Standard deviation
- Sequence of returns risk
- Path dependency
- Volatility drag
- Safe withdrawal rate
- Absorbing barrier
- Value at risk