What is Survivorship Bias?
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 Does Survivorship Bias Work?
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 Does Survivorship Bias Matter?
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.
