If you’ve been investing for any amount of time, you’ve likely experienced the gut-punch feeling of a drawdown. That sinking moment when your portfolio’s value starts to shrink, and every instinct tells you to panic. It’s not a pleasant experience, but drawdowns are an unavoidable part of stock market investing.
The silver lining? They’re also temporary. Every drawdown is eventually followed by a recovery, and understanding how this cycle works can help you stay calm and make better decisions when the market gets rough.
Let’s break down what drawdowns and recoveries mean, why they happen, and how to navigate them.
What Is a Drawdown?
A drawdown occurs when the value of your investment portfolio drops from a peak to a trough. It’s usually expressed as a percentage decline. For example, if your portfolio’s value goes from $100,000 to $80,000, you’ve experienced a 20% drawdown.
Drawdowns can happen for various reasons: market-wide corrections, economic recessions, or company-specific news. They’re a normal part of investing, but they can feel anything but normal when you’re in the middle of one.
Why Drawdowns Happen
1. Market Volatility
The stock market doesn’t move in a straight line. Prices fluctuate daily, and some swings are more severe than others. Volatility is just the cost of participating in the market.
2. Economic Cycles
The economy moves in cycles—growth, peak, contraction, and recovery. During periods of contraction, the market often experiences drawdowns as companies face reduced earnings and investors become more risk-averse.
3. Investor Sentiment
Fear and greed drive much of the market’s movement. When investors collectively panic, selling accelerates, leading to sharper declines.
What Is a Recovery?
A recovery happens when the market rebounds from a drawdown and climbs back to its previous peak. It’s the light at the end of the tunnel for investors who stay the course.
The speed and magnitude of recoveries can vary. Some are quick and dramatic, while others take years. For example:
- After the 2008 financial crisis, the S&P 500 took nearly four years to return to its pre-crisis peak.
- During the COVID-19 crash in 2020, the market rebounded to new highs within months.
Why Understanding Drawdowns and Recoveries Matters
1. Helps Manage Expectations
Drawdowns are inevitable. Knowing they’ll happen can help you mentally prepare and avoid panic when they do.
2. Prevents Emotional Decision-Making
When you understand recoveries, you’re less likely to sell during a drawdown. Many investors lock in losses by exiting the market at the worst possible time.
3. Supports Long-Term Planning
Investing is a marathon, not a sprint. Drawdowns are temporary, but long-term growth happens when you stay invested and allow recoveries to work in your favor.
How to Navigate Drawdowns
1. Stay Invested
One of the worst things you can do during a drawdown is sell your investments. Selling locks in your losses and prevents you from participating in the recovery.
I’ve made this mistake before—selling during a dip only to watch the market bounce back without me. Now, I remind myself that patience pays off.
2. Focus on Quality Investments
High-quality companies with strong fundamentals are more likely to recover after a drawdown. When the market turns south, I review my holdings to ensure I’m invested in businesses that can weather the storm.
3. Diversify Your Portfolio
Diversification spreads risk across different asset classes, sectors, and regions. If one area of your portfolio takes a hit, others might hold steady or even perform well.
For example, during the 2020 crash, my tech stocks were hit hard, but my healthcare and consumer staples holdings helped cushion the blow.
4. Rebalance Periodically
Rebalancing involves adjusting your portfolio to maintain your desired asset allocation. During a drawdown, it might mean buying more of the underperforming assets to take advantage of lower prices.
5. Stay Focused on Your Goals
Why are you investing? For me, it’s about building wealth for the future. Reminding myself of my long-term goals helps me stay calm when the market feels chaotic.
Learning From Recoveries
Recoveries teach us that drawdowns are temporary. The market has a long history of bouncing back, often stronger than before.
1. The Importance of Patience
Markets reward patience. If you stay invested through a drawdown, you give yourself the chance to benefit from the recovery.
2. Opportunities in a Drawdown
While drawdowns are stressful, they’re also an opportunity. Stocks often go “on sale” during a downturn, allowing you to buy high-quality companies at discounted prices.
3. Resilience in Investing
Recoveries remind us of the importance of resilience. Every time the market recovers, it reinforces the value of staying committed to your strategy.
Final Thoughts
Drawdowns and recoveries are two sides of the same coin. You can’t have one without the other. While drawdowns are challenging, they’re a normal and temporary part of investing.
For me, the key to navigating them has been understanding their role in the bigger picture. Yes, drawdowns feel uncomfortable in the moment, but they’re also what make long-term growth possible.
The next time you experience a drawdown, try to remember that recoveries are on the horizon. Focus on your goals, stick to your strategy, and trust the process. The market may test your patience, but staying the course is what ultimately leads to success.