In simple terms, “drawdown” is Wall Street-speak for “you lost money,” so knowing the drawdown history of an asset is important for investors as they build portfolios. This according to a recent article in The Wall Street Journal.
“It’s a fancy way of saying the market value of your account or asset declined,” explains Advisors Capital Management CIO Chuck Lieberman. “Instead of saying your stock fell in value, you had a drawdown.”
Investors can use drawdown information to guide their portfolio allocations, the article notes, “based on how much risk they can tolerate and how much return they want to target.”
Verdad Advisers founder Dan Rasmussen explains, “When you look at different asset classes, you want to understand the chance of a loss and the likely magnitude of that loss. That’s why looking at drawdowns is so essential.”
The article cites research by Verdad (spanning from January 1973 through May 2021) showing, for example, that fixed-income securities saw fewer drawdowns with a lower average magnitude. The study also found that lower drawdown risk tends to come with lower returns.