What is Survivorship Bias Risk?

Survivorship bias risk is the chance of an investor making a misguided investment decision based on published investment fund return data that reflects only successful funds rather than all funds.

Key Takeaways

  • Survivorship bias risk is the risk that the reported returns for investment funds is overly optimistic because failed funds are systematically selected out of the available data.
  • Survivorship bias is a more general bias that can apply in many contexts, but is of particular interest to investors.
  • Survivorship bias and related risks should be carefully considered before buying into any fund.   

Understanding Survivorship Bias Risk

Survivorship bias risk is a type of risk based on the concept of survivorship bias, sometimes also known as “survival bias.” This is a phenomenon that can happen in a variety of contexts. It involves evaluating a situation or drawing conclusions based solely or mainly on people or things that are prominent or visible at that time. This is usually after some sort of selection or separation process has occurred. 

Survivorship bias is a problem when the characteristics of survivors systematically differ from the characteristics of the overall original population or the target audience. This normally occurs because the selection process is not random, but is biased in some way for or against certain traits, characteristics, or behaviors. 

In an investing context, survivorship bias risk can occur when the published investment fund return data is unrealistically high because a company's poorly performing funds are closed and their returns are not included in the data. In this case, the data specifically related to those funds has already been weeded out, producing an inaccurate and incomplete picture of a company’s overall fund performance.

The danger in this scenario is that the investor will not actually see the returns they anticipate because they have based their investment decision on incomplete and misleading information. If prospective investors are only told the returns of successful funds, and not the sub par or negative returns suffered by funds that have been closed, then they will be given an overly optimistic view of the potential returns that they can expect. 

Survivorship Bias Risk and Other Risks

Survivorship bias risk is one of many reasons why investors should not rely too heavily on past returns to make their investment decisions. This is particularly true if investors are looking at a very limited period of time in the fund’s history, as there may have been some abnormal incident(s) or unusual occurrences that affected the fund’s performance during that window of time. There is also the chance that a group of investors just happened to have luck on their side at that time, and of course there is no guarantee that the luck they experienced will repeat itself.

Survivorship bias risk is just one example of the various types of risk an investor must consider when making investment decisions or planning their long-term strategy. Investors should also consider related types of risk in an investment fund. Other types of risk related to survivorship bias that investors might encounter are:

  • Non-reporting bias risk, which is the danger that overall returns are misstated because some funds, likely the poorly performing ones, decline to report their returns;
  • Instant history bias risk, which is the possibility that fund managers may choose to report performances to the public only when they have established a track record of success with a fund, while leaving out unsuccessful funds.

In addition to past performance, investors should consider factors such as cost, risk, after-tax returns, volatility, relationship to benchmark performance and more.