PERSONAL FINANCES: SEEKING SUCCESS WITHOUT LETTING IT BLIND US
This article draws a connection between the beauty of archaeological sites and that of a vacuum cleaner... passing through the robustness of warplanes... It is easy to see that the connection does not seem obvious... And yet there is one! It lies in the way we reason. These different examples illustrate a bias that tends to negatively influence some of our financial decision-making: the survivorship bias.
Investment advisor at Societe Generale Private Banking.
Seeing the dust under the carpet!
Perhaps you had the chance to travel and marvel at historical ruins that suggest a particular strength in the constructions of the past? What is the connection between the beauty of these archaeological sites and the efforts made during the sad period of the Second World War to reinforce the planes that returned riddled with bullets? Not much, except for a bias: the survivorship bias, also known as the survival bias.
This bias, with a somewhat sad name, consists of a tendency to focus, or even only remember, what has survived (in terms of success) and, at the same time, not remember or pay attention to what has not survived. Indeed, like the few Greek columns still standing, those that have resisted are much more visible than all the others. This bias was popularized by the statistician Abraham Wald during the Second World War, in his study on how to better protect warplanes returning riddled with bullet impacts. Rather than reinforcing the affected areas that had not prevented the plane from returning, the mathematician suggested reinforcing the intact parts: his conclusion being that when these parts were damaged, the plane did not return!
Just as we will only remember the strength of the Greek columns, forgetting all those that have disappeared, we will remember the great founders of successful companies in Silicon Valley, without paying attention to the numerous companies that do not survive1. And even for successful companies, the founder of a famous household appliance company regularly explains that he "made 5127 prototypes before succeeding, that is 5126 failures" before marketing his flagship vacuum cleaner! Less entertaining than our article on "the bias of ambiguity and the choice of lawnmower" but just as instructive!
Should we then conclude that it is normal to fail in financial investments before succeeding?
A help for reflection rather than an excuse!
A positive answer to the above question would probably make us more comfortable. But here, we prefer to draw some lessons from the survivorship bias rather than legitimizing the mistakes!
In personal finances, the major difficulty lies in predicting the future: a change in the macro-economic environment (inflation rates, interest rates...), achieving a target return, realizing a capital gain, etc. In this field, the survivorship bias boils down to an overestimation of the chances of success in an initiative, i.e. a focus on similar perceived successes even though they may be statistical exceptions ( "survivors") rather than representative cases.
Concretely, the risk of misunderstanding the past can be significant. Thus, studies examining the strategies or stock performance of companies tend to exclude those that have gone bankrupt or been acquired, which is why studying the long-term historical performance of stock indices can be complicated. There are numerous publications by researchers discussing the difficulty of judging the performances of fund categories, some of which may have disappeared.
Beyond statistics, the survivorship bias tends to exacerbate optimism. By focusing only on successes (forgetting that if 100% of winners have tried their luck, 100% of losers have too!), the perception of the reality and the probabilities of financial success in an investment can be distorted, leading to excessive risk-taking. Similarly, by focusing on a type of investment that has worked well for an investor, one may be tempted to see it as a systematically suitable solution, ignoring the troubles of other investors in the same asset class.
In short, it is important to pay as much attention to the less visible failures as to the successes!
Without going as far as 5127 drafts, this article has required so many invisible efforts!...
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