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In the world of investing, what is survivorship bias. Why should you care?
In the world of investing, what is survivorship bias. Why should you care?
“Survivorship bias is the tendency for failed companies to be excluded from performance studies because they no longer exist. It often causes the results of studies to skew higher because only companies which were successful enough to survive until the end of the period are included.” (http://en.wikipedia.org/wiki/Survivorship_bias) I should care, because I plan on investing once I actually have money to invest. It is important to look at the whole picture when investing; only seeing successful companies will leave you with a false sense of security.
This type of bias occurs when financial analysis only includes companies or products that didn’t fail. This type of bias can give very attractive looking perspective because it doesn’t include performance below a certain threshold.
For example when a Mutual fund reports performance it may only report on funds that are currently successful. Funds that are not successful are quietly excluded or merged together with more successful funds to hid the losses. In fact this type of combining the unsuccessful with the successful is very common financial strategy.
Caveat emptor!
Outstanding answers! I thought you captured the point beautifully Katherine. Aaron added to your points. Understanding should drive our financial decision-making. You both are very good examples. Well done!