Chapter 4 · Mission 2 · 1973–1977

Risk and maximum drawdown

Risk isn't only “losing money”: it's how much your investment moves along the way and whether you can stand it.

Goes with Mission 2: Riding out a storm.

The idea

In short

1Risk isn't only “losing money”: it's how much your investment moves along the way and whether you can stand it.
2Volatility measures how much returns swing. Maximum drawdown is the biggest fall from a peak to the next low.
3Recovering is not symmetric: required gain = 1 ÷ (1 − fall) − 1. −20% needs +25%; −40% needs +67%; −50% needs +100%.
4Recovery time: how long until you're back at the previous peak, in dollars and in purchasing power.

In the data

What history shows

How far US stocks were below their last peak, 1928–1949

The worst fall (maximum drawdown) was −82%, reached in 1932. A fall of that size needs a gain of +448% just to get back.

Real data, January 1928 to December 1949: years before any mission, so nothing is given away. Monthly returns from Robert Shiller and Aswath Damodaran.

Real figures

The numbers

Finish Mission 2 to see these real figures.

Remember

Takeaways

Finish missions 2, 4 and 5 to see the takeaways.

Practice, not scored

Quiz

1. Your portfolio has a fall of −30%. How much must it rise to get back?

Finish Mission 2 to see this question.