We learn nothing about those who were dragged in the opposite direction when we are told that dolphins save drowning people by pushing them to the shore. Let’s look at the paradox of “survivor’s mistakes” and why they’re risky for your money.
Many people have heard how Mark Zuckerberg, Bill Gates, and Steve Jobs, who were once unknown, dropped out of school to focus on their inventions. In the fall of 2005, Zuckerberg dropped out of university to focus on Facebook. In 1976, Steve Jobs, an Apple co-founder, dropped out of college to build the first computer in his garage with his friend Steve Wozniak. Bill Gates dropped out of Harvard two years after starting his studies to join Paul Allen in founding Microsoft.
These are remarkable tales, especially when you consider that all three companies are now among the top five in terms of market capitalization. Others, on the other hand, find examples of successful people who face challenges in life to be too motivating. Many people may believe, “If they can succeed without a university, then I can, too.” But, unfortunately, this is a common misunderstanding, because we often overlook those who dropped out of school and did not succeed.
This is known as the “survivor’s error,” which occurs when we interpret data for one group (“survivors”) while there is virtually no data for the other (“dead”), resulting in distorted conclusions that ignore the missing data.
How can you make a mistake in the stock market, neglecting the “survivor’s mistake”.
At the lecture “Psychological traps of Financial Markets,” NES rector Ruben Enikolopov discussed the “survivor’s mistake” for investors. He described a situation in which the average yield of an ETF is calculated without taking into account the dynamics of funds that have closed due to poor performance. Assume that an ETF’s average five-year yield is 15%. “These data tell us that if any fund survives, then you will have 15%. One small question remains: what is the probability that he will survive? ” – explains Enikolopov.
Because everyone talks about “rockets,” and they prefer to keep silent about failures, investors frequently analyze successful deals and strategies of professionals. People form opinions in this way: “If it helped him earn money, it will help me as well.” You must, however, pay attention to failed cases.
So, last year, the founder of Ark Invest, Katie Wood, attracted special attention to herself, who invests only in companies with “breakthrough innovations”. The sensational” Arkov ” ETF funds brought investors fantastic returns in 2020. Ark Genomic Revolution grew by 178% last year, the flagship Ark Innovation — by almost 150%, Ark Fintech Innovation-by 107.3%.
As a result of Wood’s leadership, active ETF funds have seen unprecedented growth. According to Bloomberg data, the funds launched 115 active products and only 51 passive ones from the beginning of the year to the end of June. For the entire year of 2020, about 50 active ETFs were launched. Many managers were inspired by Katie Wood’s success and decided to launch similar products that are well-liked by investors.
And it appears that if one fund was able to achieve a profit margin of more than 100%, the other will most likely be able to do the same. Stories about failed active ETF funds, some of which had to close due to losses, are less common and are less widely reported in the media. In fact, demonstrating such a result is quite difficult. Over the last ten years, 82 percent of fund managers have failed to outperform the benchmark S&P 500 index, and 87 percent have failed to do so for the past 15 years.
There is also a “survivor’s error” when looking at the dynamics of the S&P 500 index. When we examine the chart from the beginning of its calculations, we can see that it is consistently increasing over time. However, we must keep in mind that some companies are routinely removed from the index while others are added. As a result, we only see 500 “survivors” who have better dynamics and are able to push the index to new highs. At the same time, we are no longer following the outsiders who have tainted the index’s dynamics. For example, Tesla was added to the S&P 500 index in 2020, and Moderna was added in July of this year. These firms have now taken the place of the “dead,” and their movements have an impact on the index.
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