#54 Survivorship bias: Only the surviving funds make history

The term survivorship bias originates from World War II. At that time, the US Navy examined aircraft returning from combat missions to determine which areas had the most bullet holes. The obvious idea was to better armor precisely those areas.

However, statistician Abraham Wald advised that the aircraft's engines should be better armored. This was because the aircraft that had returned had no bullet holes in this area. Those whose engines had been hit had crashed and could not be examined at all.

What the military had not considered was that the aircraft that had been shot down were not included in their statistics. Since then, statisticians have referred to this as survivorship bias. It is a mistake to analyze only the survivors.

How bias distorts fund statistics

What applied to aircraft also applies to investment products. Many funds «crash» when their performance lags behind the benchmark over a longer period of time. They are closed or merged with other funds – and thus disappear from the official statistics.

Only the successful products remain visible in the comparisons. Fund companies naturally prefer to refer to those funds that have performed particularly well. That is why every fund company always has a whole range of funds on offer. One or two will always perform well.

This creates the impression that actively managed funds can regularly beat the market. In reality, however, the statistics only show the survivors. If fund companies were also required to disclose the performance of their closed products, the picture would be much less rosy.

ETFs are not spared either

This effect even plays a role with ETFs. The market offers countless theme funds – from cannabis and rare earths to smart beta, equal weighted, momentum, and low volatility. And even in sustainable investing, there are «fifty shades of green.» Something is always doing well – and it is precisely these products that are then heavily promoted.

However, past performance is not a reliable indicator of future returns. Just because a fund or ETF has performed well in the past does not mean that it will continue to do so in the future.

We also encounter this fallacy in everyday life. When friends or acquaintances talk about their successful stock or crypto investments, you can assume that they have concealed one or two failures from you.

Have you ever lost money due to survivorship bias? If so, I would love to hear your story. Send me an email with your experiences.