How to Survive Portfolio Drawdowns
A drawdown is the peak-to-trough decline in portfolio value before a new high is reached. In the 2008 financial crisis, the S&P 500 experienced a 56.8% drawdown from October 2007 to March 2009. A $1 million portfolio fell to $432,000. In the 2020 COVID crash, the drawdown was 33.9% over just 23 trading days. A $500,000 portfolio fell to $330,500 in less than a month.
These events are not anomalies. They are the recurring price of equity ownership. Since 1928, the S&P 500 has experienced a drawdown of 10% or more approximately once every 1.2 years, 20% or more approximately once every 3.5 years, and 30% or more approximately once every 8 to 10 years. An investor with a 40-year time horizon should expect to endure roughly 35 corrections of 10%+, 11 bear markets of 20%+, and 4 to 5 severe crashes of 30%+.
Surviving these drawdowns, remaining invested and ideally buying more, is the single largest determinant of long-term investment success. The math is simple: selling during a 30% drawdown requires a 43% gain just to break even, and the investor must correctly time both the exit and the re-entry. Missing even a few of the best recovery days permanently impairs returns.
The Anatomy of a Drawdown
Drawdowns do not announce themselves. They begin as ordinary market pullbacks that look, at first, indistinguishable from the dozens of 3% to 5% dips that occur every year. The 2008 crisis started with Bear Stearns's hedge fund collapse in June 2007, fourteen months before Lehman Brothers failed. The COVID crash started with scattered news reports from Wuhan in January 2020, two months before the market bottomed.
The psychological progression during a drawdown follows a recognizable pattern.
Denial (0% to -10%). This is just a dip. Markets always come back. The financial media is overreacting.
Anxiety (-10% to -20%). This might be serious. Portfolio losses are becoming materially large. The investor begins checking balances more frequently.
Fear (-20% to -30%). Something is genuinely wrong. Cable news runs 24-hour crisis coverage. Friends and family express worry. The impulse to sell becomes powerful.
Panic (-30% to -50%). The loss feels permanent. The investor imagines the portfolio going to zero. Selling provides immediate psychological relief. "I'll buy back in when things settle down."
Capitulation (-40% to -50%). Those who have not yet sold do so at or near the bottom. Trading volume spikes. Sentiment reaches maximum pessimism. This is historically the point of maximum opportunity for those who still have the conviction and the capital to buy.
Recovery (bottom to new highs). The market rebounds, initially without the investors who sold. Those who sold at -35% watch the market recover 20%, 30%, 40% without them, and struggle to find the courage to buy back in at higher prices than they sold.
Preparation Before the Drawdown
The time to prepare for a drawdown is before it happens, not during. Several structural decisions make the difference between surviving and succumbing.
Appropriate asset allocation. The equity allocation should reflect the maximum drawdown the investor can tolerate without selling. Historically, a 100% equity portfolio has experienced drawdowns of -50% to -55%. An 80/20 stock/bond portfolio experiences drawdowns of -35% to -40%. A 60/40 portfolio stays within -25% to -30%. If the investor's panic threshold is -30%, an 80/20 allocation is too aggressive and a 60/40 allocation is more appropriate, regardless of what optimization models suggest.
Emergency fund outside the portfolio. Three to six months of living expenses in a high-yield savings account prevents the forced sale of equities during personal financial emergencies that often coincide with market downturns (recessions cause both layoffs and market declines simultaneously).
No margin debt. Leveraged portfolios face margin calls during drawdowns, forcing the investor to sell at the worst possible prices. A portfolio that declines 30% on margin may trigger forced liquidation, converting a temporary drawdown into a permanent, levered loss. Every catastrophic blow-up in individual investor accounts involves margin.
Written investment plan. A document that specifies the portfolio's asset allocation, rebalancing rules, and predetermined responses to various drawdown levels. Reading this document during a panic is not the same as following it, but it provides a reference point that counteracts the emotional narrative of the moment.
During the Drawdown
Stop watching financial news. Cable news and social media amplify fear during drawdowns because fear drives viewership and engagement. The financial information needed to make good investment decisions, annual reports, earnings data, balance sheet analysis, is not found on CNBC during a crash. Limiting media consumption during severe drawdowns reduces the emotional stimulus that triggers selling.
Check the portfolio less frequently. Kahneman's research shows that the pain of loss is roughly twice the pleasure of gain. Checking a declining portfolio daily means experiencing intense loss aversion daily, each time increasing the probability of an emotional sell decision. Reducing check frequency to weekly or monthly lowers the cumulative emotional toll.
Rebalance, do not sell. If the drawdown has pushed the equity allocation below target (stocks down, bonds up), the systematic response is to sell bonds and buy stocks, restoring the target allocation. This is the mechanical opposite of panic selling and is one of the most reliable ways to buy equities at depressed prices. Investors who rebalanced into stocks at the March 2009 bottom captured the beginning of an 11-year bull market.
Continue automatic contributions. Dollar-cost averaging during drawdowns buys more shares at lower prices, reducing the average cost basis and increasing the number of shares that participate in the eventual recovery. An investor contributing $1,000 per month who maintained contributions through the 2008-2009 crisis purchased shares at prices 50% below pre-crisis levels, shares that subsequently appreciated 400% or more.
Evaluate individual holdings on fundamentals. A stock that has declined 40% requires a different response depending on why it declined. If the underlying business is intact and the decline reflects market-wide selling, the appropriate action may be to add to the position. If the business itself is deteriorating, selling to prevent further loss may be warranted. The question is always: has the investment thesis changed?
The Recovery: Where Wealth Is Created
Bear markets are where the seeds of future wealth are planted. The S&P 500's strongest years have consistently followed its weakest. After the 38.5% decline in 2008, the index returned 26.5% in 2009. After the 33.9% COVID crash from February to March 2020, the market returned 68% from the March 23 bottom to year-end. After the dot-com bust reached its bottom in October 2002, the market returned 29% in the following year.
These recovery returns are not distributed evenly over time. They are concentrated in the early days and weeks of the rebound. JP Morgan research found that six of the ten best trading days in the S&P 500 over the past 20 years occurred within two weeks of the ten worst days. Missing these recovery days because of a poorly timed exit eliminates most of the recovery's benefit.
Bank of America calculated that an investor who stayed fully invested in the S&P 500 from 1930 to 2020 would have earned an annualized return of 9.8%. An investor who missed the ten best days each decade would have earned just 0.6% annually. The difference between full investment and missing a handful of recovery days is the difference between building wealth and barely keeping up with inflation.
Building Emotional Resilience
The ability to endure drawdowns is not a fixed personality trait. It can be developed through exposure, education, and practice.
Study market history. Every severe drawdown in market history was followed by a recovery to new highs. The 1929-1932 crash (89% decline) recovered by 1954. The 1973-1974 bear market (48% decline) recovered by 1980. The 2000-2002 dot-com bust (49% decline) recovered by 2007. The 2008-2009 crisis (57% decline) recovered by 2013. Knowing this history provides intellectual conviction during the next crisis, even when emotional conviction wavers.
Define "surviving" in advance. Before a drawdown, write down the specific actions to take at each level of decline. At -10%: review allocation but take no action. At -20%: rebalance if allocation has drifted. At -30%: deploy cash reserves into equities. At -40%: continue contributions and avoid media. These pre-commitments transform the drawdown from an open-ended crisis into a series of predetermined actions.
Talk to other long-term investors. During drawdowns, social pressure is overwhelmingly toward selling. Everyone on television and in social media is panicking. Counteracting this requires deliberately seeking the perspective of experienced, long-term investors who have survived previous drawdowns and benefited from staying invested.
Remember the asymmetry of missing the recovery. The cost of selling at the wrong time is asymmetric. An investor who holds through a 30% drawdown and a subsequent 43% recovery is back to even. An investor who sells at -30%, waits for "clarity," and re-enters at -10% from the original peak has permanently lost 21% of their capital. The penalty for mistiming an exit far exceeds the theoretical benefit of avoiding the final portion of the decline.
Drawdowns Are the Cost of Returns
Equity returns are not free. The long-term premium that stocks earn over bonds and cash is compensation for enduring exactly these kinds of drawdowns. If stocks never declined 20% or 30%, everyone would own them, the price would be bid up until expected returns equaled the risk-free rate, and the equity premium would disappear.
The drawdown is the price. The compounded return is the reward. Investors who pay the price, by staying invested, rebalancing, and continuing contributions through the decline, earn the reward. Those who refuse to pay, by selling during drawdowns and waiting for the "all clear," forgo the premium that makes long-term equity investing worthwhile.
There is no version of long-term equity investing that avoids drawdowns. There is only the investor's response to them.
Put these principles into practice. Track fundamentals, build portfolios, and analyze stocks with AI-powered insights.
Start Free on GridOasis →