What is Underwater period?

An underwater period is the stretch of time an investment spends below its previous highest value. It starts at a peak, runs through the fall and the low point, and ends only when the value climbs back to that old high. The name comes from charts that shade the area below the prior peak, so the portfolio appears to be under water. The size of the fall is the drawdown, meaning the percentage decline from a peak to a later low. The underwater period measures how long the whole episode lasts.

Say you invest $10,000 and it grows to $12,000, which becomes its new high. Over the next eight months the market declines and the portfolio drops 25%: $12,000 × 0.75 = $9,000. To get from $9,000 back to $12,000 it needs a gain of $3,000, and $3,000 ÷ $9,000 = 33.3%. If that recovery takes a further 22 months, the underwater period is 8 + 22 = 30 months, counted from the peak, not from the low. Deeper losses stretch the climb back because the required gain grows faster than the loss: a 50% loss needs a 100% gain to recover, and an 80% loss needs 400%.

A common misunderstanding is that recovery time is one fixed number. It depends on how it is measured. After the 1929 crash, US stocks (Shiller data) took 25 years to regain their peak in price terms, 15 years once dividends are included, and 7 years with dividends and inflation taken into account. Inflation is the general rise or fall in prices across the economy. Reinvested dividends kept compounding through the decline, and prices across the economy fell in the early 1930s. The figure also depends on the start date, and a portfolio receiving regular contributions often gets back above its invested amount before the index regains its peak. Past underwater periods describe history and say nothing certain about the next one.

For a private investor building a long-term portfolio, the length of an underwater period can matter as much as the size of the loss. Many investors cope with a sharp decline that recovers within a year but find it much harder to stay invested through many years below an earlier balance, and selling during that time turns a temporary loss into a permanent one. Duration also matters for people drawing income. Withdrawals taken while a portfolio is underwater leave less capital to benefit from the recovery, a problem known as sequence of returns risk. Looking at both the depth and the duration of past falls gives a fuller picture of what holding an investment has felt like.

By Dr. Harry Hamann

What is the difference between drawdown and underwater period?
Drawdown measures how far a portfolio falls from its peak, in percent. The underwater period measures how long it stays below that peak, from the high until a new high is reached. Two falls of the same depth can have very different underwater periods.

How long did it take US stocks to recover from the 1929 crash?
Using Shiller data, US stocks took 25 years to return to their September 1929 peak in price terms, 15 years including dividends, and 7 years including dividends and adjusting for inflation.

Why does a bigger loss take so much longer to recover?
Because the recovery starts from a smaller base. A 50% loss needs a 100% gain to get back to the peak, a 55% loss needs 122%, and an 80% loss needs 400%.