During World War II, the Navy realized it was losing a lot of aircraft and could better armor its planes to increase their survival. After analyzing where its planes had suffered the most damage, it determined that it needed to reinforce the planes’ wingtips, central body and elevators.
But a statistician named Abraham Wald argued otherwise. He thought the Navy should reinforce the armor of the planes’ nose, engines and mid-body. But why would he suggest that when the planes were taking more damage to the wingtips, central body and elevators? Because in reality, they weren’t. The planes getting shot in the nose area, engines and mid-body were being destroyed from the damage and weren’t making it back to be analyzed.
The Navy thought it had discovered where its planes were suffering the most damage. Instead, it had discovered where its planes could take damage without being destroyed. It wasn’t looking at the whole sample set.1
Source: McGeddon, “Survivorship Bias,” Wikimedia Commons, https://commons.wikimedia.org/wiki/File:Survivorship-bias.png, accessed March 2019.
Interesting stuff … but what does this have to do with investing?
This phenomenon of excluding the aircraft that had crashed and never made it back is called “survivorship bias.” And it commonly comes up when analyzing mutual funds and other investments. When we are evaluating a group of investments and don’t count those that failed entirely, we miss seeing the full picture. This can cause us to draw conclusions that may be incorrect.
For equity mutual funds in the 15-year period from 2002-2017, only 51%2 of the mutual funds in existence at the beginning of the period survived. To put that in context, if you pick the “wrong” funds, you could see some of them disappear over the course of your investment lifetime.
Our Investment Committee’s selection process for funds in an investment portfolio is purposefully rigorous and takes into consideration investment strategy, fund manager history, costs and other factors that we believe will impact the long-term viability of a fund. It is also for this reason that our firm avoids investment fads and the flavor du jour that appears to solve for the perceived market problem of the moment but is likely to go out of fashion just as quickly.
This rigorous selection process does not mean that the funds in a portfolio are bullet proof. There will still be time periods when their investment style may be out of favor or the market experiences a pullback, and they will suffer some damage — 2018 was a prime example of this. However, a rigorous selection process also means that these funds are better positioned to survive another day even after getting banged up, and they are around to experience the upside when markets recover.
The financial media is vying for your clicks by publishing stories that highlight geopolitical and economic risks and often promises a one-size-fits-all investment that is sure to overcome the obstacles that the current environment presents. If you look back at history, you can find examples of similar investments that have failed in the past — they just tend to recede in investor’s memories because people often focus only on what has survived. A sound investment strategy that is meant to last for the long-term needs to be built with investment products that can weather different market environments. It’s important to make sure yours can.
Read more about our approach and investment philosophy.
