Survivorshiop Bias

Dear Sir or Madam,

In my last post on cognitive biases, I explained the hindsight bias, which causes people to see past events as predictable, even when their outcome was highly uncertain at the time.

Today, I want to introduce you to another cognitive error—one that can lead you to false conclusions and cause you to systematically overestimate your own chances of success, particularly when selecting investments.

When analyzing statistics on the success of actively managed investment funds, many people fall victim to a classic cognitive bias: survivorship bias.

At first glance, most statistics on past fund performance don’t look too bad. The majority of funds perform similarly to the market, meaning they haven’t “destroyed” value. While there are quite a few losers, if you include the managers who achieved roughly market returns, you also see nearly as many winners. The data often resembles a classic bell curve (Gaussian distribution), suggesting that you have a 50/50 chance of landing on the winning side. All you have to do, it seems, is pick the right fund manager—preferably one who has already demonstrated a successful track record.

The statistics on successful fund managers are misleading

Beyond the fact that these managers’ success stories are rarely sustainable, most historical performance reviews lack a crucial piece of information: You only see the funds that survived the full period under review.

And this is no minor rounding error. Consider this example: A 35-year study by Vanguard founder John Bogle analyzed the returns of over 350 U.S. equity funds. By the end of the study, more than two-thirds (!) of the funds had disappeared.

And why were they closed? Not because they were too successful—but because they were failing. Their poor performance drove investors away, leading fund providers to shut them down. When you factor in these missing funds, the odds of success in this “loser’s game” decline dramatically.

One Bill Gates vs. One Million Failures

Business history is filled with tales of remarkable success—and survivorship bias often distorts our perception here as well:

The student who seemingly built a global empire from nothing, like Mark Zuckerberg with Facebook (Meta). The hedge fund manager George Soros, who became an investing legend by making a bold currency bet that paid off. Venture capitalists who struck it rich with a single successful investment.

But pause for a moment and consider the full picture. The survival rate for startups is just 10–15%, depending on the industry. Even venture capital investors—professionals with expertise and entire teams dedicated to assessing investments—have an incredibly slim chance (often less than 1%) of backing the next unicorn.

The vast majority of venture capital investments are later written down in value or completely written off. The overwhelming number of failures is conveniently overlooked in favor of the few standout success stories.

Will my son be the next CR7?

This reality check applies to all areas of life, no matter how sobering it may be.

In my free time, I coach an under-10 football team—my son is a passionate player, just like I was as a child. Of course, he dreams of becoming the next CR7 (Cristiano Ronaldo). Back in my day, my idol was also a No. 7—Mehmet Scholl.

But the numbers tell a different story: Out of hundreds of young talents, only a handful will ever make a living from their skills. For every Ed Sheeran, there are countless talented young singers and songwriters whose music will remain a lifelong hobby.

Achieving success requires an extraordinary mix of factors, many of which are entirely beyond one’s control.

That’s why, in all areas of life—including the capital markets—you should maintain a realistic and reflective perspective on those rare, exceptional success stories.

Best regards,

Your

Stefan Heringer

P.S.: I welcome your thoughts at nachdenken@neunundvierzig.com.

01/06/2024