When a broker tries to sell you a mutual fund, or your advisor touts the performance of a fund he or she wants to put your money into, it is modus operandi to show how wonderful the fund has performed against its benchmark, or relative to its peers.
Before you jump into the fund, consider the impact of survivorship bias on those published performance numbers. As the PSY-FI blog explains, survivorship bias is the result of the all-too-often habit of mutual fund companies to merge the assets of underperforming funds into the successful ones.
Your fund might have a terrible year – perhaps miss its benchmark by 50% or more – but if you blink you just might miss that your fund was closed and your assets have moved into a succesful fund with a great track record….voila, in an instant your fund is gone and your investment is in a fund that has the best 10 year track record of any fund in its category!!! Your bad investment has magically disappeared. Congratulations!
PSY-FI explains a number of other creative ways fund companies improve perceived returns, including ‘easy history’ bias or ‘easy data’ bias, but the main lesson for investors is simply caveat emptor!
