Not an island reality show: “Survivorship”

Many of us have seen the reality TV show, “Survivor.” People compete not to be thrown off the island.

But survivorship is something totally different. It’s a source of bias in mutual fund returns. Here’s how it works. Say a mutual fund company starts five different funds, each trying a different strategy. Three do well and two fail miserably. Those two funds get closed.

Now, the three remaining funds look good — even above average! And that will be true, even if the five funds, taken together, had mediocre statistics or worse.

The lesson: Beware of mutual fund companies that imply they can “beat the market.”

For more on survivorship bias, see http://www.indexfunds.com/articles/20010413_survivorship_com_act_LS.htm