The Real Risk To Investing: Understanding and Managing Portfolio Drawdowns
Introduction
For investors, risk is an ever-present companion to return. Every financial plan, portfolio model, and investment strategy makes some attempt to account for it. Yet despite the sophistication of modern risk tools, many fail to focus on what investors actually experience — not abstract measures of volatility, but the real, tangible declines in their portfolio value that we refer to as drawdowns.
Drawdowns are more than just uncomfortable; they are disruptive. They alter investment behavior, erode confidence, and — if unmanaged — can significantly compromise long-term returns. At Asbury Research, we believe managing drawdowns is not just an academic exercise, but a foundational discipline for building durable portfolios.
This paper explores what a drawdown is, why it matters more than traditional risk measures, and how incorporating drawdown-aware strategies into portfolio construction can help investors stay on track through full market cycles.
What Is a Drawdown?
In its simplest form, a drawdown is the decline in portfolio value from a recent peak to a subsequent trough. It is typically expressed as a percentage and is only considered complete once the portfolio value recovers to a new high. Unlike volatility, which is a measure of fluctuation, drawdowns measure actual loss — something far more relevant to how investors perceive and react to risk.
To illustrate: If a portfolio peaks at $100,000 and subsequently falls to $80,000 before recovering, it has experienced a 20% drawdown. Recovery from that loss requires a 25% gain just to get back to even — a dynamic that highlights the asymmetric nature of losses and gains in investing.
Drawdowns vary in depth and duration. Some are short-lived and quickly reversed by the next rally. Others, like those seen during the 2008 Financial Crisis or the 2000 Dot-Com collapse, can take years to recover — dragging not only on financial capital but also on investor psychology.
Why Drawdowns Matter
Investors don’t live in spreadsheets. They live in the real world, where watching your savings decline by 30%, 40%, or more in a short period can be emotionally jarring. The significance of drawdowns lies in three primary areas: mathematical, behavioral, and strategic.
- The Mathematical Impact: The mathematics of recovery are unforgiving. A 10% drawdown requires an 11.1% return to break even. A 30% decline demands a 42.9% gain. A 50% loss? It requires a full 100% return to recover. The steeper the drawdown, the longer and more difficult the recovery. This compounding penalty explains why two portfolios with identical average returns can have vastly different ending values — if one of them experiences deeper or more frequent drawdowns.
- The Behavioral Impact: Drawdowns often trigger panic. Even experienced investors can be swayed by fear and uncertainty, leading to ill-timed decisions like exiting positions at market bottoms or abandoning long-term strategies. These reactions are understandable — we are hardwired to avoid loss. But they are also avoidable when proper risk management is in place. Unmanaged drawdowns invite emotional decision-making. Managed drawdowns promote discipline, resilience, and staying invested — all key ingredients to long-term success.
- The Strategic Impact: From a strategic perspective, the real risk is not short-term volatility, but permanent impairment of capital. Drawdown-aware strategies are designed not to eliminate losses entirely — a practical impossibility — but to limit them to tolerable levels. This gives portfolios a better chance to recover quickly and take full advantage of future opportunities.
The Problem with Traditional Risk Measures
Modern portfolio theory has long relied on tools like standard deviation, beta, and Sharpe ratio to quantify risk. We use them ourselves when creating models and trading strategies. While useful in some contexts, these measures fall short in assessing what most investors care about: “How much could I lose, and how long will it take to get it back?”
Volatility is a symmetrical concept. It treats upside and downside moves the same. But investors don’t react emotionally to upside volatility — they celebrate it. It’s only the downside that causes distress and leads to costly behavioral errors.
By focusing more on drawdowns — their size, frequency, and duration — investors can develop a more accurate picture of risk and build strategies better aligned with their goals and risk tolerance.
A Historical Perspective on Drawdowns
Over the past 25 years, U.S. equity markets have experienced several significant drawdowns. The three most notable — the Dot-Com Bust, the Global Financial Crisis, and the COVID-19 Crash — each demonstrate how markets can fall sharply and unexpectedly:
- 2000–2002 Dot-Com Bust: S&P 500 fell 49% and required seven years to recover.
- 2007–2009 Global Financial Crisis: S&P 500 dropped 57%, with a 5.5-year recovery period.
- 2020 COVID Crash: A rapid 34% decline in just one month, but an unusually quick recovery due to unprecedented fiscal and monetary intervention.
While each event was different in cause, the result was the same: a sharp reversal that tested investor discipline and highlighted the importance of drawdown management.
The Asbury Approach: Managing Drawdown Risk
At Asbury Research, we believe that proactive drawdown management is essential. It is a core principle behind the quantitative models and tactical strategies we provide to our clients.
Our Correction Protection Model (CPM) was specifically developed to identify early signs of elevated risk in the market and reduce exposure before significant drawdowns occur. Similarly, our Asbury 6 model acts as a daily “market health monitor,” using six diverse metrics to assess whether risk conditions are favorable or deteriorating.
These models do not aim to predict the market. Rather, they provide a rules-based, data-driven framework for managing risk. By signaling when to reduce equity exposure — and when to re-enter — they help investors sidestep the worst of market declines while remaining positioned for upside.
The goal is not to avoid every downturn, but to avoid the ones that do lasting damage — both to portfolios and to investor confidence.
Conclusion
Drawdowns are not just a feature of investing; they are a defining force. While investors cannot avoid them entirely, they can manage their exposure to them — and in doing so, preserve both their capital and their discipline.
At Asbury Research, we believe that a sound investment strategy must prioritize drawdown management alongside return generation. It is this balance — of growth and protection, of risk and reward — that leads to more consistent outcomes and a smoother ride through unpredictable markets.
About Asbury Research
Founded in 2005, Asbury Research is a Registered Investment Advisor (RIA) that provides data‐driven technical and quantitative investment research and asset management to professional and private investors. Asbury Research has been recognized as one of the Top Five Investment Research Services Providers in 2024 by Financial Services Review.
To learn more, visit AsburyResearch.com or contact us to schedule a consultation.