Survivorship Bias

What It Is:

Survivorship bias occurs when companies that no longer exist -- due to bankruptcy, acquisition or any other reason -- are not accounted for when calculating investment returns. 

How It Works/Example:

For example, suppose an investor is researching returns on Portfolio XYZ over two consecutive years: 2006 and 2007.

In 2006, the portfolio is comprised of Stock A, Bond B and Mutual Fund C.

In 2007, Bond B was put into a seperate "loser" portfolio because of poor performance. Now Portfolio XYZ is comprised of only Stock A and Mutual Fund C. If the 2-year portfolio returns are calculated based on Stock A and Mutual Fund C returns without accounting for the poor returns of Bond B in 2006, the results will have survivorship bias and will be skewed to the upside.

Why It Matters:

Survivorship bias fails to account for all variables affecting a portfolio's or investment company's valuation. As a result, historical valuation becomes skewed, often creating the appearance of favorable, but inaccurate, performance.