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What are some examples of survivorship bias in investing?

Survivorship bias is the tendency to focus on the successes of a particular group or individual, while ignoring or downplaying the failures or shortcomings of that same group or individual. For example, if you were studying the success rates of different business strategies, you might be biased towards the strategies that are currently being used by successful businesses, and overlook the strategies that were tried and failed by those same businesses.

Survivorship bias is a type of selection bias that can dramatically skew perceptions and investment outcomes. Here are some examples of how survivorship bias can impact investing:

1. Mutual Funds: The world of mutual fund investing is rife with survivorship bias. Mutual funds that perform poorly over a certain period are often either closed down or merged with better-performing funds. In such scenarios, their performance record, especially the poor ones, tend to be erased from databases. What’s left are the records of those funds that have survived, creating an apparent history of above-average results. This can lead to a significant overestimation of potential returns for an average investor. For instance, if an investor looked at the performance of active funds in the UK over the past decade, they might see a group that outperformed their benchmarks. However, that would not account for all the funds that underperformed, were closed or merged away due to the sub-par performance. As a result, an investor may end up having an unrealistic expectation of the potential returns and the ability of fund managers to outperform the market.

2. Stock Indices: Survivorship bias also significantly affects the perception of stock market performance. Take, for example, the FTSE 100 index, which is composed of the largest 100 companies in the UK by market capitalisation. When a company in the FTSE 100 struggles, shrinks, or otherwise falls below the top 100, it gets replaced by a more successful company. Over time, this continuous replacement of underperformers with outperformers can give a skewed picture of market performance, suggesting that investing in the stock market is less risky than it might actually be. The losers are simply no longer visible, making it seem like the average company did better than it actually did.

3. Startup Investing: When investing in startups, especially in the technology sector, survivorship bias is particularly strong. We often hear about successful startups such as Deliveroo, Monzo, or BenevolentAI that have achieved billion-pound valuations or successful exits. However, for each successful startup, there are many more that fail. According to some studies, the failure rate for startups can be as high as 90%. When investors hear about the exceptional returns achieved by successful venture capital firms or angel investors, they might not be aware that these returns are often calculated based on the few big winners, while ignoring the many losses. This could lead investors to overestimate the potential returns and underestimate the risks involved in startup investing.

4. Real Estate: The property market is another area where survivorship bias can be found. We often see data on the ever-increasing prices of properties in prime locations. Yet, what we don’t see are those properties that have depreciated in value, been demolished, or otherwise exited the ‘investment property’ category. Over time, the fact that the unsuccessful properties are no longer included in the data gives a biased picture of the real estate market as a whole. This can lead investors to underestimate the risks involved in real estate investing and overestimate the potential returns.

5. Cryptocurrencies: With the surge in popularity of cryptocurrencies such as Bitcoin and Ethereum, more and more people have started investing in them. However, just like in other areas, survivorship bias is present in cryptocurrency investing. There are thousands of cryptocurrencies, and while a few like Bitcoin and Ethereum have seen dramatic price increases, many others have failed completely. If an investor looks at the performance of cryptocurrencies without taking into account the ones that failed, they might overestimate the potential returns and underestimate the risks involved in cryptocurrency investing.

In conclusion, survivorship bias can significantly skew perceptions of the investment landscape. Whether it’s mutual funds, stock indices, startups, real estate, or cryptocurrencies, it’s vital to remember that the survivors are not fully representative of the entire field. Investors should take this bias into account and make more informed and realistic decisions based on a comprehensive understanding of potential risks and returns. They should always bear in mind the proverbial warning that past performance is not indicative of future results.

“If you have a 10% chance of a 100x return, you should take that bet every time – even if it’s going to feel bad 9 out of 10 times.” – Jezz Bezos

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