Article

Understanding drawdown and how it may impact your retirement.

You can’t always control when you retire or what happens next in the markets. You can, however, control what you’re invested in. For investors who are planning for retirement, it’s important to choose investments that reduce the depth and duration of declines in their investment portfolio. By doing so, you can reduce the impact of downturns in the market, leaving more money for retirement.

Measuring risk

Investors typically use standard deviation as a measure of risk. Without delving into the math, standard deviation measures the movements in price that a security could experience.

While standard deviation is easy to grasp, a higher standard deviation means higher risk since it doesn’t provide enough “real world” information. That’s because a security and an investor’s portfolio can have a high standard deviation and still increase in value.

Drawdown is a better measure of risk because it measures the decline in the value of an investment. The drawdown to an investor’s portfolio can be considered by looking at these three factors:

• Depth: How far a portfolio declines (e.g., “The investor’s portfolio declined 12%.”)
• Duration: How long the decline occurs, and how soon until it recovers (e.g., “The investor’s portfolio declined for 23 days.”)
• Frequency: How often a portfolio declines in value (e.g., “The investor’s portfolio declined three times last year.”)

The chart is for illustrative purposes only.

When planning for retirement, think about drawdown

Recognizing the impact of drawdown is essential. Investors who retire during a down market will have less to fund their retirement than someone who retires during a positive period in the market. Once retired, you will likely have a more “conservative” portfolio (e.g., more fixed income funds and equity funds) and may not benefit much from the long-term growth potential of equities, so it’s important to start retirement with as high a level of assets as possible.

You can minimize the impact of drawdown on your portfolio by choosing investment solutions with built-in protection strategies, and you may be in a stronger position when the time comes to use your investments as a source of retirement income.