What is survivorship bias in the stock market?

49

Survivorship bias, also termed survivor bias, is the tendency to look at the performance of existing funds and securities in the stock market in India as an extensive sample of market performance without considering the securities and funds that have gone under. Survivorship bias can lead to the overestimation of historical performance and other qualities of a market index or a fund. It can also misguide an investor who makes an opinion based solely on the performance data published.

Examples of survivorship bias


One of the best examples of survivorship bias is the survivorship bias plane in the Second World War. The American military told Abraham Wald, a mathematician, to monitor how to defend their planes. The military examined the plane which had come back from the mission and looked where the planes were hit the most and then strengthened those areas. However, this study was focused only on the planes which were hit and came back, but they were misguided to survivorship bias as their study had not included the planes which were hit and did not come back. Just like this, when an investor takes an opinion of the share market that is misguided due to bias, it is called survivorship bias.

What is backfill bias and how to overcome it?


Backfill bias
is a slight modification of survivorship bias in which a new fund is included in a provided index and its past performance is considered, thereby inflating the performance of the index. Steps for how to overcome survivorship bias or backfill bias are stated below:

  • Use multiple data resources

It is important to refer to multiple data resources to overcome survivorship bias. You should try to find as many inputs as possible from different resources. You should not depend only on the quantitative data or make a verdict fully based on a diminished number of customers. You should also not solely focus on the data from the testing and research made by you. You can make the optimum judgment by using both qualitative and quantitative data to learn your main drivers and understand the investment’s performance.

  • Understand the context of the data

A common misapprehension is that the data is an unprejudiced fact. Data is not indifferent; it inherits its views from the people who have collected it either intentionally or unintentionally. Without reference to its context, data is of no use and the conclusion made from such data is also of no use. Hence, you need to understand the context of the data collected by its providers in the stock market before investing by relying on such data to overcome survivorship bias.

  • Imaginary scenarios

You can use alternate models to imagine ‘what if’?  By expanding your views, you permit yourself to fetch more scenarios for making a decision, and this will help you come up with a lot of innovative solutions, which will be suitable according to your needs. In the stock market, you need to think about all the possible ways an investment can pan out to make a better decision and overcome survivorship bias.

Conclusion

It is important to find a trusted source from where you can collect data and use it to your advantage. Narrowing down on a good investment platform can also help with goal-based investing, tracking investment performance, timely portfolio rebalancing, and long-term wealth creation.