How to avoid 'survivorship bias' and build a financially secure future

Choosing to ignore past failures can be a costly mistake for investors to make, experts say

A desire to learn from the successful is a natural instinct for many people, but this can backfire if they don't also consider failure. Alamy

In 1943, the Second World War was hanging in the balance. The US Air Force was suffering badly from the German air defence. Too many of their planes were going down to enemy fire. The military knew armour would help but couldn’t protect the whole plane because it would be too heavy to fly.

Researching the returning planes, they found many were receiving most bullet holes to the wings and tail and concluded they needed to increase armour to these areas.

However, mathematician Abraham Wald didn’t agree. He believed the US Air Force’s analysis was missing a valuable part of the picture – the planes that were hit but hadn’t made it back.

The military was planning to armour the wrong parts of the planes. The bullet holes they were looking at actually indicated the areas a plane could be hit and keep flying – exactly the areas that didn't need reinforcing.

He concluded: “Don't armour the wings and tail. Armour the engine. Those are the planes that have not survived, and thus are not available for research.”

The US Air Force suffered tens of thousands of casualties during the Second World War, but without Wald’s advice, this would have been far higher. His insight and reasoning illustrates what we now call “survivorship bias”. The human tendency to focus on survivors or successful outcomes and ignore non-survivors or failures.

It’s easy to fall into this trap. A desire to learn from the successful is a natural instinct, but it can backfire. After any process that leaves behind survivors, the non-survivors are often removed from your view. A classic case of “out of sight, out of mind”. If failures become invisible, then naturally you pay more attention to successes.

Say you’re planning to start your own business because there are so many successful start-ups in your sector. You are ignoring the fact that only successful start-ups survive to become examples. However, 90 per cent of all start-ups fail within five years – more in certain industries.

Seeing only successes, day after day, might inspire you to leave the comfort of a corporate career to enjoy the thrill, excitement and growth of a start-up. You’re actually seeing evidence you should avoid.

Another example is a gym featuring those who’ve toned up quickly as a result of working out at their facilities but, of course, what they never show is those who signed up but achieved no more than a depleted bank account.

In my own work on maximising the returns on capital our clients entrust us with, survivorship bias is the tendency to view the performance of existing stocks or funds in the market as a representative comprehensive sample, without regarding those that have gone bust.

The result? Overestimation of historical performance and general attributes of a fund or market index. Survivorship bias can increase the chances of an investor making a misguided investment decision based on published investment fund return data. Making decisions based on the wrong facts.

Effective decisions around money or life are governed by two external truths. Firstly, a lack of clarity on understanding yourself or the situation will lead to poor decisions. Secondly, lasting change requires you to be honest with yourself, be disciplined, rigorous with the data and persistent.

Survivorship bias can lead us to overly optimistic beliefs because failures are ignored as they are not as visible as successes. It can also lead us to the false belief that the successes within a group have some special properties, rather than just coincidence.

And that is what pulls us towards best-selling diet gurus, celebrity chief executives, superstar stock pickers and get-rich-quick cryptocurrency traders. You look to the successful for clues about how to better live your life — and how you, too, can survive similar forces against which you also struggle.

The problem here is that you rarely take away advice on what “not” to do and on what you should avoid. And that’s because most don’t know this. Information like that is lost along with those who don’t make it out of bad situations or who do not make it to magazine covers.

So, how do you avoid being duped by survivorship bias?

Recognise that luck plays a huge role in success, although the path is always obvious in hindsight.

Whenever you read a success story, think of all the people who tried to do what that person did and failed. When looking for advice, also look for what not to do (even when you don't want to hear it).

Most of the time, success is all about avoiding large catastrophic failures while absorbing small, manageable damage. Without doubt, helping my clients avoid costly mistakes is part of the peace of mind and value that comes with professional advice.

As Max Lerner, the late Russian-born American journalist, famously said: “History is written by the survivors.”

What action could you take today to remove your blinders and consider what you don’t see?

Sam Instone is co-chief executive of wealth management company AES