Staying invested works, but drawdowns deserve your respect too

Corrections in India tend to be sharper for stocks favoured by retail investors, highlighting their greater vulnerability to sentiment-driven swings.

Drawdowns — prolonged declines in a stock’s price from its previous high — are an inherent part of long-term investing. While much of investment literature focuses on wealth creation and compounding, the quieter reality is that the path to long-term gains is often paved with significant and sustained losses.

An analysis of long-term data on stock market drawdowns, recoveries, and investor behaviour offers a clear framework for understanding the patterns of market declines and setting realistic expectations across different phases of the market cycle.

The nature and depth of drawdowns

Data from the US stock market over multiple decades reveals that sharp declines are not outliers but rather part of the investing experience.

●       The median US stock saw a 65 percent decline from peak to trough, typically unfolding over 2.5 years.

●       The average drawdown, skewed by severe collapses, stands at 81 percent, and the average recovery, similarly skewed by a handful of outsized winners, is 358 percent.

Crucially, most stocks never fully recover:

●       Only 54 percent of stocks historically have made it back to their previous high.

●       The median recovery reaches just 90 percent of the prior peak, falling short of breakeven.

These statistics challenge the popular belief that stocks, if held long enough, will always recover. While the broader index may recover, individual constituents often do not.

Frequency and duration of severe losses

Drawdowns of significant magnitude are more common than typically assumed:

●       Roughly one in six stocks experiences a >95 percent loss at some point.

●       Severe drawdowns (95 to 100 percent) tend to take 6 to 7 years to bottom out, compared to ~1 year for milder (<50 percent) declines.

This data indicates that deep losses are not rare anomalies but are structural features of equity markets. The emotional and financial cost of holding through such periods is substantial, especially when the eventual outcome is uncertain.

Probability of recovery

Recovery is possible — but not probable — for all stocks. Base rates suggest:

●       80 percent of stocks that fall more than 50 percent do eventually recover.

●       However, for stocks that fall >90 percent, only 10 percent ever recover to previous highs.

Even among stocks that survive, the rebound often does not lead to breakeven. Median recoveries take these stocks to approximately 16 percent below prior peaks, even after rebounding 4–5x from the bottom.

This implies that while large gains are possible post-drawdown, they often don’t fully reverse earlier losses. For investors, relying on a full recovery as a strategy can be misleading unless the stock is backed by fundamental resilience.

Market overreaction and mispricing

The notion that markets overreact to bad news — and thus undervalue “loser” stocks — has some empirical support.

●       Early research by De Bondt and Thaler (1985) suggested that stocks with very poor prior returns often outperform in the following years.

●       However, more recent analyses show that the median loser stock continues to underperform, despite a few high-profile recoveries.

The data indicates that while some deeply fallen stocks may become turnaround stories, many remain permanently impaired. This makes it difficult to distinguish between temporary overreaction and long-term deterioration.

Concentration of wealth creation

An often-overlooked fact is that most of the stock market’s long-term wealth creation comes from a small subset of stocks.

●       A study by Hendrik Bessembinder found that just 4 percent of US stocks accounted for 100 percent of net wealth creation over the past century.

●       Many of these outperformers, including Amazon and Apple, went through deep drawdowns (sometimes exceeding 80 percent) before delivering exceptional long-term returns.

This underscores a paradox: the few stocks that create outsized wealth often look like permanent losers before they rebound. However, most stocks that decline severely do not follow this trajectory. The challenge for investors is identifying which is which—a task that is far from trivial.

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Drawdowns in Indian equity markets

Indian equities exhibit similar characteristics, though drawdowns have historically been shallower:

●       Major corrections in the Nifty 50 have ranged from -10 percent to -30 percent, with 2025 marking one of the worst starts to a year in two decades.

●       Valuation-based corrections in India typically average around 30 percent, though the 2025 decline has so far been around 20 percent.

Notably, corrections in India tend to be sharper for stocks favoured by retail investors, highlighting their greater vulnerability to sentiment-driven swings.

The cost of waiting for corrections

Many investors adopt a strategy of waiting for a market correction (e.g., 10 percent) before investing. While this may seem prudent, there are several flaws:

●       As markets rise, the required correction becomes larger in point terms. A 10 percent correction from 85,000 (Sensex) is far more significant than from 60,000.

●       Corrections are frequent, but their timing is unpredictable. Historical data shows that while 46 percent of the time markets are in a 10 percent correction, these periods are not always aligned with investor expectations.

●       The opportunity cost is significant: Investors who wait often miss long periods of growth and may underperform by 30–60 percent or more in extreme cases.

●       Psychological drag: Missing out leads to hesitation and inertia, compounding underinvestment over time.

Thus, waiting for corrections as an entry strategy is often counterproductive, both financially and emotionally.

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Implications for investors

Drawdowns are not rare events — they are foundational elements of investing. For serious investors, especially those managing personal portfolios over long horizons, several key lessons emerge:

1.      Expect significant declines. Even diversified portfolios can see deep losses. Individual stocks can decline >90 percent and may never recover.

2.      Diversification remains essential. Since it's difficult to predict which stocks will recover, spreading exposure reduces the impact of failed recoveries.

3.      Be wary of turnaround bets. While some beaten-down stocks do recover, most do not. Fundamental analysis should guide decisions, not just the depth of the drawdown.

4.      Market overreaction creates opportunities — selectively. Value may emerge post-collapse, but due diligence is essential. Focus on high-conviction, quality businesses, not merely those that have fallen.

5.      Avoid over-optimism during rebounds. Even stocks that recover strongly may not return to previous highs. Survivorship bias often paints a rosier picture than reality.

6.      Patience is necessary — but not blind hope. Holding through a downturn requires discipline, but holding a structurally broken stock in hopes of breakeven is counterproductive.

Drawdowns are the price of long-term equity returns. Knowing how deep they can go - and how few stocks fully recover - changes how investors approach risk, resilience, and reward.

The data tells us that more than half of fallen stocks never revisit their peak. Those that do often require years of patience and come with elevated risk. At the same time, some of the greatest long-term winners are born out of these very declines.

The challenge for investors is not just in enduring volatility but in discerning when a drawdown presents a real opportunity—and when it signals structural decline.

Investing is not about avoiding drawdowns. It’s about surviving them with your capital and confidence intact.

The writer is Co-founder & Executive Director, Prime Wealth Finserv Pvt Ltd.

Disclaimer: The views expressed by experts on Moneycontrol are their own and not those of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions.