Glossary/Risk

Drawdown

Also known as Peak-to-trough decline, Underwater loss

A drawdown is the decline in an investment or portfolio from a previous peak to a later value before a new peak is reached. It is normally expressed as a percentage and tracks the investor’s experienced loss from the high-water mark.

Editorially reviewed 2026-07-29

Why drawdown matters

Drawdown translates fluctuating returns into a path of loss and recovery that investors can readily understand. It affects spending capacity, leverage, redemptions, and behavior. Two portfolios can earn the same annualized return but create very different experiences if one suffers a deep interim decline. Managers monitor current drawdown to judge whether losses remain consistent with a strategy and whether liquidity and risk limits can withstand further stress.

How it is applied

For each observation, analysts compare the current portfolio value with the highest value recorded previously. The difference divided by that peak is the drawdown. A drawdown series begins at zero at each new high, becomes negative as value falls, and returns to zero upon recovery. Reports commonly show depth, start date, trough date, recovery date, and duration. Calculations should use a consistent return series after relevant fees and cash flows.

Formula

Dt = (Vt / max(V0...Vt)) - 1
Dt
Drawdown at time t
Vt
Portfolio value at time t
max(V0...Vt)
Highest portfolio value observed through time t

Portfolio example

A portfolio grows from 100 to 125, falls to 105, and later reaches 128. At 105 its drawdown is 105 divided by 125 minus 1, or -16%. The drawdown starts after the 125 peak and ends only when value exceeds 125. An investor entering at 110 may have a personal loss different from the published drawdown, which is measured from the portfolio’s own prior peak.

How to interpret it

A current drawdown of -10% means the portfolio stands 10% below its previous high, not necessarily that every investor has lost 10%. Depth describes magnitude while duration describes time without a new peak. Recovery requires a larger percentage gain than the loss: after a 50% decline, a 100% gain is needed to return to the peak. Drawdowns should be compared with strategy, leverage, market environment, and stated tolerance.

Limitations and common misconceptions

A drawdown is path-dependent and changes with observation frequency and start date. Monthly data can hide severe daily losses, while stale private valuations can understate both depth and duration. Historical drawdowns do not establish the worst future loss, and a portfolio at a new high shows zero drawdown despite possibly carrying substantial risk. The measure should sit beside scenario analysis, volatility, liquidity, and maximum drawdown rather than replace them.

Sources and further reading

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