The Dangerous Allure of Survivorship Bias

The way to build wealth in markets is to do things that are smart and safe. If you develop a playbook of smart and safe investing decisions, you can return to that playbook over and over again.

The repeat application of smart and safe habits is a wealth-accumulation process. It’s valuable to create a process like this and then stick with it for years, or even decades, on the path to your long-term goals.

Emphasizing “smart and safe” sounds obvious when it comes to investing. But there is another way to operate in markets: Making moves that are foolish and risky, and then hoping those moves work out.

Why would anyone take the foolish and risky path? For lots of reasons, far too many to list here. A desire to get rich quick, a fear of missing out (otherwise known as FOMO), boredom and a craving for action, and a sense of envy or jealousy are just a few examples.

There is also the psychology factor. The foolish and risky path can work, at least a portion of the time. And when it does, the winner enjoys a bright spotlight. This tempts others to feel jealous, or to consider making the same foolish moves.

A famous example of this is the “Phantom Gambler” of Las Vegas.

As Michael LaPointe of the Paris Review retells it, the Phantom Gambler walked into Binion’s Horseshoe Casino on Sept. 24, 1980 with two brown suitcases. One suitcase was empty. The other held $777,000 in cash.

After entering Binion’s, the Phantom Gambler walked to the casino cage and converted his $777K into chips. He then calmly bet the whole amount on a craps table wager at 2-to-1 odds. If he won, the house would pay the Phantom Gambler $1.5 million. If he lost, he would walk away with nothing.

The Phantom Gambler won the wager, took his $1.5 million worth of winnings — filling up both suitcases — and disappeared. It was the biggest dice wager in the history of America.

Four years later, in March 1984, the Phantom Gambler appeared at Binion’s again — this time with $538,000 — and made the same bet. Once again, he won.

But after his second win, the Phantom Gambler — whose real name was William Bergstrom — couldn’t stay away. Nine months later, in November 1984, he showed up at Binion’s to make a third all-or-nothing bet. This time, he lost. They found him dead in a hotel room two months later.

The reason the Phantom Gambler is a legend to this day — why the papers gave him that nickname, and why his story was a staple of Horseshoe marketing for decades — is because he won the first two times.

When they work out, foolish and risky wagers tend to get lots of positive press. But the spotlight turns away when the same wagers fail, and it rarely shines at all on the overwhelming number of gamblers (and investors) who tried something foolish and lost.

The term that explains this is “survivorship bias.”

Also known as “survival bias,” survivorship bias is the cognitive error of focusing on the small percentage of winners in a group who tend to hog the spotlight, while ignoring the far larger number of non-winners who never received attention.

By hiding or outright ignoring the true ratio of wins to losses — with the hidden losses far more frequent than the wins — survivorship bias tends to distort perception into making a certain type of individual, or a certain type of activity, appear far more successful than it actually is.

Survivorship bias is common in marketing materials. If you start watching for it, you can see it everywhere. For example, survivorship bias is built directly into the business model of national lottery promotions. Here is how that works:

• The odds of winning a national U.S. lottery, like Mega Millions or Powerball, are roughly on the order of 300 million to one.
• At the same time, the odds of getting struck by lightning in the U.S. in any given year, according to National Geographic, are about 700,000 to one.
• So your odds of getting struck by lightning are 428 times greater than the odds of winning a national lottery — but you are tempted to forget those odds through tactics of survivorship bias, like showing the winner holding a giant check, in order to make you think, “That could be me.”

Survivorship bias is also common in the financial press, where it can have a subtle, but dangerous impact. For example, when a high-tech startup founder is featured on the cover of a financial magazine, the temptation is to think: “That person became a zillionaire and I didn’t.”

But that same financial magazine will never point out that, for every high-tech startup founder who got rich enough to make a magazine cover, there are literally hundreds if not thousands of startup founders who went hard after their dream, lived off ramen noodles, and worked 90-hour weeks for years on end — with absolutely nothing to show for it.

It’s a similar thing with hedge fund managers and star analysts who are praised for their bold calls on financial television. The reason they are being interviewed and praised, is because the big call worked out in the first place. There is no mention of the thousands upon thousands of big calls that were wrong — because those guys aren’t taking a victory lap.

Survivorship bias and the media’s tendency to indulge in it obscure a very important fact: The investing path to wealth is ultimately about odds and probabilities.

When you focus on investment decisions that are smart and safe, you continuously put the odds in your favor with each decision you make. You can’t know whether your next investment decision will work out, of course. But you can know that, if you emphasize smart and safe investing habits, you can win consistently over the long-term, while avoiding the costly setbacks that can destroy a portfolio.

In this configuration of things, time is your friend. The law of large numbers is helping you.

When an investor does things that are foolish and risky, on the other hand, the odds are continuously against him or her. Glory-chasing habits might pay off in the short run — through a big financial score, or a temporary spotlight — but in the long run, this is a recipe for destroying wealth, not building it, because time is the enemy for those who disrespect the odds.

One takeaway here is to cast a wary eye on success stories. Ask yourself how much survivorship bias was involved, especially if the person being praised took big risks to do what they did.

Were those risks smart? Where they safe? If not, this person may not be an inspiration or an idea source. They may have been just lucky — and they might even be a cautionary tale.

The second takeaway is to seek inspiration and ideas from investors with proven track records — those with a history of making choices that are smart and safe over and over again, over long periods of time.

This is one of the valuable aspects of our Billionaire’s Club, the roster of legendary billionaire investors whose investment picks we follow and analyze in TradeStops and Ideas by TradeSmith. These individuals have shown an ability to invest wisely for decades, with a high degree of consistency in the quality of stocks they buy over time.

Of course, this way of thinking and investing isn’t necessarily flashy or worthy of prominent headlines. That’s why the real survivors tend to keep to themselves, quietly building wealth in a smart and safe fashion, while the financial press jumps from one sensationalist headline to another.

TradeSmith Research Team