Survivorship Bias

Survivorship Bias is the logical error of focusing on the “survivors” of a particular process while ignoring the “failures,” leading to overly optimistic conclusions. Imagine a study of lottery winners to find the secret to wealth; you’d completely miss the millions who bought tickets and won nothing. In the world of investing, this bias is a dangerous trap. It happens when we only look at the performance of companies or funds that are still around today. The data from those that went bankrupt, were acquired, or simply shut down due to poor performance is often excluded from the analysis. This creates a skewed, rose-tinted view of reality, making investment returns look higher, easier, and less risky than they actually are. It’s like judging the safety of rock climbing by only interviewing the climbers who made it back to the ground. For a value investing practitioner, recognizing and correcting for this bias is a critical step in making sound, rational decisions based on a complete picture of history, not just the highlights reel of the winners.

This cognitive shortcut can warp your perception of risk and return, luring you into costly mistakes. It’s one of the most common and powerful forces that leads investors astray.

This is a classic example of survivorship bias in action. Let's say an investment company launches 10 different mutual funds. Over a decade:

• Three do exceptionally well.
• Four are mediocre.
• Three perform so poorly they are quietly closed or merged into other funds.

When the company markets its performance, it will naturally highlight the fantastic returns of its seven surviving funds. The data for the failed funds vanishes into a “graveyard,” making the firm's average track record appear far more impressive than it truly was. An investor looking at this data might think the fund manager is a genius, when in reality, their success could be due to luck spread across a wide, and partially failed, portfolio. The same illusion applies to hedge funds and other managed investment products.

Business bestsellers are often riddled with survivorship bias. They pick a handful of wildly successful companies—the “survivors”—and analyze their common traits: a charismatic CEO, a unique company culture, a bold strategy. The implicit promise is that if you emulate these traits, you too can be successful. But this analysis completely ignores the thousands of failed companies that also had charismatic CEOs, unique cultures, and bold strategies. The trait didn't guarantee success; it was just present in the winners who got lucky or had other, less obvious advantages. As Warren Buffett has noted, “The swimmers who crossed the river are lionized, but nobody looks at the swimmers who drowned.” Believing in a simple “secret sauce” derived from survivors can lead investors to overpay for companies with fashionable stories, ignoring the fundamental analysis of their business and its intrinsic value.

The good news is that you can train yourself to spot and correct for this bias. It requires a healthy dose of skepticism and a commitment to digging deeper than the marketing materials.

Instead of just looking at the current components of an index like the S&P 500, try to find out which companies have been dropped from it over the years. Why did they fail? Studies that include “delisted” stocks (those removed from an exchange) provide a much more sober and realistic picture of long-term market returns. When evaluating a fund manager, don't just look at their currently active funds. Ask for a list of all funds they have ever managed, including the ones that have been closed. This complete dataset reveals the manager's true skill, not just their lucky wins.

Many investment strategies are promoted with “back-tested” results showing how they would have performed in the past. Be extremely cautious. A common flaw is testing the strategy on the current list of S&P 500 companies and applying it backwards in time. This is a massive case of survivorship bias because it implicitly assumes you knew in 1990 which companies would survive and thrive to be in the index today! A valid back-test must use point-in-time data—that is, the universe of stocks that were actually available at each point in the past, including those that eventually went bust.

This is the ultimate defense for a value investor. Don't be seduced by stories of spectacular returns. Instead, focus on the soundness of the investment process. A robust process, like the one advocated by Benjamin Graham, involves:

1. Thoroughly analyzing a business's fundamentals.
2. Calculating a conservative estimate of its intrinsic value.
3. Insisting on a significant margin of safety—buying the asset for much less than you think it's worth.

This approach doesn't guarantee every investment will be a winner. But because it's based on logic and risk management rather than chasing past performance, it protects you from the siren song of survivorship bias and improves your odds of long-term success.