Understanding Maximum Drawdown (Loss)

There is a lot of confusing terminology in the finance industry, and a lot of measurements and equations are used to determine and illustrate risk and return. We can't completely avoid some of this terminology but we will do our best to demystify it, and one of the key terms we would like to familiarise you with is called Maximum Drawdown.

Many funds suffered their worst losses in the market crash of 2008, and saw prolonged periods (up to 23 months) during which time they lost money. Maximum Drawdown represents the maximum percentage of one's investment that could be lost if a person bought a unit trust at the highest point of the biggest losing period for that fund, and sold it at the lowest value over the same period.

It is easy to identify the maximum drawdown when looking at a graph, so hopefully the illustration below will help you get to grips with this concept.

This graph shows the unit price for a unit trust over a 10 year period, and we have highlighted the maximum drawdown months when the fund lost the most amount of money, continuously. If you bought at the point marked "Bought" and sold at the point marked "Sold", you would have experienced the biggest loss possible over the entire 10 year period.

IMPORTANT NOTE even if you had bought at that worst possible time, your investment could have still been worth more than you started out with had you continued to hold onto the unit trust and not sold it at the bottom of the graph as shown.