“I recently ran an experiment where I generated random 7 to 50-stock portfolios from the 500 largest U.S. traded companies and measured their performance over the past 10 years. All of the randomly selected portfolios outperformed the S&P500 and BRK.B in terms of compound annual rate of return. Has anyone else tried this experiment? I then convinced myself that it worked by looking at the Guggenheim ETF RSP that holds an equal weight portfolio of the S&P500 stocks. It too beat the S&P500 over the past 10 years. I posted a video on YouTube of the experiment and the results”Before I dig any deeper into this article, take a moment and see what the problem the above statement runs into. The answer, survivorship bias. By purchasing the top companies of today and backtesting them over the past ten years, you are just taking stocks which have already won and bought them at some point in the past – completely skewing your returns. Survivorship bias is a big problem in the mutual fund industry. Many mutual fund companies will eliminate poorly performing mutual fund products, or push poor performing funds into a larger, better performing fund to show better results.
Survivorship Bias – How does it work?
I was recently lurking around an online investment forum when the following post came up –