Glossary / Markets

Volatility drag

Volatility drag is the gap between the average annual return of an investment and the return an investor actually compounds, caused by losses reducing the base on which later gains are earned.

Up fifty percent then down fifty percent averages zero and leaves you down twenty five.

The more volatile the path, the wider the gap between the arithmetic average and what ended up in the account.

Where people get it wrong

Quoting average annual returns as though they compound. The geometric return is the one you can spend.

The framework behind it Drawdown recovery math sets out the rule, the arithmetic and where it breaks.

Read the framework

Related terms

Drawdown A drawdown is the fall from a portfolio's peak value to its trough, expressed as a percentage, and recovering from one requires a larger percentage gain than the loss because the gain is calculated on a smaller base. Sequence of returns risk Sequence of returns risk is the danger that poor returns arriving early in retirement permanently damage a portfolio, because withdrawals during a fall sell more units and leave less to recover with.

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