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Rupert Hargreaves
Rupert Hargreaves
Articles (952)  | Author's Website |

Why You Need to Understand Survivorship Bias

Some thoughts on this vital psychological bias

September 20, 2019

If you don't know what survivorship bias is, I highly recommend doing some research on the topic.

Over the past several years, I have come to realize that understanding this is just as important as understanding any other investment concept because it can have such a significant impact on how you interpret the success of others.

Outside influence

There is no getting away from the fact that as investors, others will always influence us. We can try as hard as possible to reduce this influence, but eliminating it is virtually impossible.

A great way to improve your investing is to listen to the advice and follow the actions of other well-known investors. So if you are following this strategy, you can't really eliminate outside influence.

So what is survivorship bias, and why does it matter? This psychological bias is the error of only concentrating on the people or things that have achieved success. This can lead to false conclusions, particularly in the investment world.

For example, Warren Buffett (Trades, Portfolio) is considered to be the greatest investor alive today. He's made hundreds of billions of dollars for himself and his investors over the past six decades by investing in stocks.

During the first few decades of his career, he made a name for himself taking large positions in his favorite businesses, including Sanborn Map, Geico and the Washington Post.

If you look at this example in isolation, you might conclude Buffett's highly concentrated strategy is an excellent way to get rich. But that would be a mistake. The guru has made a success of the policy (partly because he's a great investor and party because of luck -- by his own admission), but he is a rare example.

There are thousands (possibly hundreds of thousands or even millions) of other investors around the world who have utterly failed following the same investment approach.

This is survivorship bias in action. Buffett is a great success. However, he is one in 7.7 billion. The probability of being able to repeat his success is so slim it's not even worth considering.

Failures outnumber success

Buffett is an extreme example, but I think it perfectly illustrates what I am trying to say here.

As investors, we need to pay attention not just to investment success stories, but the failures as well. And I guarantee you the failures outnumber the successes by a significant percentage. We need to understand that most of the time, investment returns don't live up to expectations. You have a much higher chance of losing everything then becoming the next Buffett.

Realizing this is the first stage to overcoming survivorship bias and improving your investment process. Once you understand this bias exists, you can look to enhance your understanding of the investment world and seek out examples of disasters from which you can avoid. After all, learning from other people's mistakes is a lot easier than making the mistakes yourself.

Developing the strategy

After identifying survivorship bias exists, it becomes easier to build your own investment strategy (or that's what I've found anyway).

We are constantly inundated with the success stories of others. If you start asking yourself, "Would I be able to do that?" or "Do I have the experience to do that?" you will learn a lot more about yourself. It's all part of the journey.

Being tricked into following an investment strategy you are not comfortable with, because you have been influenced by survivorship bias, could be a fast-track to losses.

So that's why I believe it is imperative to understand survivorship bias and the impact it has on our investing decisions. You might not think its power is influencing you, but survivorship bias is everywhere. The only way we can become better investors is if we are aware of its influence.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

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