What Is Survivorship Bias?
Let me explain survivorship bias directly to you—it's the tendency to look at the performance of existing stocks or funds in the market as if they're a complete picture, without accounting for those that have failed or gone bust. This leads to an overestimation of historical performance and the general qualities of a fund or market index.
Survivorship bias risk means you, as an investor, might make a poor decision based on published return data that doesn't include the full story.
Key Takeaways
- Survivorship bias happens when only the winners are considered, while the losers that disappeared are ignored.
- This can show up in mutual fund performance evaluations, where merged or defunct funds aren't included, or in market indices where dropped stocks are discarded.
- It skews average results upward for the index or surviving funds, making them seem better because underperformers are overlooked.
Understanding Survivorship Bias
You need to understand that survivorship bias is a natural issue that makes the funds still around more visible, so people see them as a representative sample. It occurs because many funds get closed by managers for different reasons, leaving only the existing ones in the spotlight.
Funds close for various reasons, and market researchers track this to highlight survivorship bias. They study fund closings to understand historical trends and improve how we monitor fund performance.
There are plenty of studies on this, like Morningstar's report 'The Fall of Funds: Why Some Funds Fail,' which covers fund closures and their downsides for investors.
Fund Closings
There are two main reasons funds close: first, they might not get enough demand or asset inflows to stay open; second, and more commonly, they're closed due to poor performance.
If you're an investor in a closing fund, you're affected right away. Companies typically offer two options: full liquidation, where your shares are sold and you might face tax issues, or merging into another fund, which is often better because it transitions shares without tax reporting, though it carries over performance data that contributes to survivorship bias discussions.
Morningstar regularly reports on survivorship bias, and you should be aware of it as an investor because it can influence performance data without you realizing. While merged funds might include some closed fund performance, usually closed funds' data isn't carried forward, leading to bias. This means you might think current funds represent all past efforts accurately, so I recommend doing qualitative research on strategies to check if previous attempts failed.
Closing to New Investors
Don't confuse a full fund closing with closing to new investors—that's different and can actually signal popularity and strong returns drawing attention.
Reverse Survivorship Bias
Reverse survivorship bias is rarer; it's when low-performers stick around, but high performers get dropped. You see this in the Russell 2000 index, a subset of the smallest 2000 securities from the Russell 3000, where loser stocks stay small and remain, but winners grow too big and leave the index.
Other articles for you
An opco is an operating company in a structure that separates business operations from property ownership to gain financial advantages, often used in REITs.
The guns-and-butter curve illustrates opportunity costs in an economy by showing tradeoffs between producing military goods and consumer goods.
The accounting rate of return (ARR) is a metric used to evaluate the profitability of investments by comparing average annual profit to initial investment.
Like-kind properties are similar real estate assets exchanged without tax liability under IRC Section 1031.
The Securities Act of 1933 is federal legislation aimed at protecting investors through transparency and anti-fraud measures in securities markets following the 1929 crash.
Earnings yield measures a company's earnings per share relative to its stock price, helping investors assess value and potential returns.
Smurfing is a money laundering technique where large sums are broken into smaller transactions to evade regulatory reporting.
Hard dollars refer to direct cash payments made by investors to brokerage firms for services like research and account maintenance, contrasting with soft dollars paid through commissions.
Value deflation, or shrinkflation, is a business tactic where companies reduce product quantity or quality while keeping prices the same to mask rising costs.
The W-4 form is an IRS document employees use to inform employers how much tax to withhold from paychecks based on personal and financial details.