Think of how many people, while growing up, who thought they’re good enough to become a professional NBA or NFL player, how many thought they could become a professional poker player or investor, how many thought they could become an award-winning actor, writer, scientist, director, or musician.
If you’re like most people, you probably think that survivorship bias is something that only happens to other people. After all, who would be foolish enough to base their investment decisions on the success stories of a few lucky survivors?
As it turns out, quite a lot of people fall victim to survivorship bias without even realizing it. This form of cognitive bias can lead investors to make suboptimal decisions by causing them to overweight the importance of recent events and ignore data that contradicts their preconceived notions.
In this article, we’ll take a look at what survivorship bias is and why it’s so dangerous for investors. We’ll also discuss some steps that you can take to avoid falling prey to this biases.
What is Survivorship Bias?
Survivorship bias is the tendency to focus on the successful outcomes while ignoring the failures. This form of cognitive bias leads people to believe that certain strategies are more effective than they actually are because they only consider the cases where those strategies have worked.
For example, let’s say that you’re considering investing in a new mutual fund. One of the funds has a return of 10% over the past year, while the other has a return of 5%. Which one would you invest in?
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If you choose the first fund, you’re falling victim to survivorship bias. By only looking at the one-year returns, you’re ignoring all of the other factors that could affect your decision. What if the second fund has outperformed the first fund over the past five years? What if the fund with the 10% return only has a handful of assets under management, while the other fund has billions?
These are all important factors that you need to consider before making your decision. However, because of survivorship bias, many investors focus on short-term performance and ignore data that doesn’t fit their narrative.
Why is Survivorship Bias Dangerous?
Survivorship bias can be extremely dangerous for investors because it often leads them to make suboptimal decisions. For example, an investor might choose to invest in a mutual fund with a history of strong performance, without considering whether or not that performance is sustainable.
This can often lead to investors chasing returns and taking on more risk than they should. In some cases, it can even lead them to invest in fraudulent investments. After all, if an investment scammer can convince you that their scheme worked for someone else, there’s a good chance that you’ll fall for it hook, line, and sinker.
So what can you do to avoid falling prey to survivorship bias? First and foremost, you need to be aware of its existence and how it can impact your decision-making process. Second, take the time to do your own research instead of blindly following what others are doing . third ,developing ,and sticking to ,a sound investment strategy will help keep you disciplined when everyone around you is making impulsive decisions .
Finally , remember that past performance is no guarantee of future results . Just because something worked in the past doesn’t mean it will work in the future . So don’t get too caught up in chasing returns ; focus on finding investments that fit your overall goals and risk tolerance . By following these steps ,you can avoid making costly mistakes and keep your portfolio on track .