On survivorship bias with the S&P 500
Hello,
It's been a little while, to put it lightly, since I wrote to you in the last newsletter. Also, welcome to those of you who are new here.
I've been doing some soul searching about purpose and my 'why'. I completely abandoned my social media, and newsletter because I no longer enjoyed making videos and content around property, but didn't realise at the time. I carried on and tried to push through, as I feel like that is what we should do when things get tough. Until I just couldn't anymore.
Then I read this quote from How to Take Smart Notes by Sönke Ahrens, which really resonated:
We are still so used to the idea that a great outcome requires great effort that we tend not to believe that a simple change in our work routines could not only make us more productive, but the work also more fun. But doesn't it make much more sense that the impressive body of work was produced not in spite of the fact that he never made himself do anything he didn't feel like, but because of it? Even hard work can be fun as long as it is aligned with our intrinsic goals and we feel in control. The problems arise when we set up our work in such an inflexible way that we can't adjust it when things change and become arrested in a process that seems to develop a life of its own.
So I've had a change in philosophy. Going forward I'm going to make my content focused on alignment: alignment between what I find fun to write, read, research, talk about and what might be interesting to you.
This week, the theme I want to talk about is risk, specifically survivorship bias, which is a little symbolic, I guess, since it's my first newsletter in a long time :)
One big fallacy of human nature is that we tend to behave as if the future will closely resemble the present and the recent past, when time and again we have seen this is not true.
In my personal life, with relationships, more than once, things can seem stable, but one event, in an instant, can forever change things. Or family members who I viewed as a bedrock of my life growing up can fall out in a bad way that I never expected.
I learnt that the only constant is change, with people, with markets, with anything in the world. Nothing can be taken for granted.
Things can and do change very suddenly.
So one thing on my mind a lot these days is to focus on being present.
Risk in the markets
I am noticing a lot of financial influencers nowadays advising everyone to put everything in index funds, specifically the S&P 500, which, in my opinion, is not inherently a bad investment. My issue is a reckless underestimation of the risk.
You see them post these over-simplified compound interest numbers. The premise is this: you assume 10% growth on average, you invest a manageable amount every month and after 30 years, you'll have a crazy number like £5 million or something. They imply that outside of short-term fluctuations, you are guaranteed those returns as long as you have a timeframe of 15-20 years. The reasoning is that because it has done this for the last 30 to 40 years, it will continue to do so, which is ridiculous.
It's a feature of survivorship bias where we are neglecting the unconditional sample. We are discounting all of the indexes that performed badly over the last 70 years or so (that seemed reasonable at the time) and using hindsight to pick the S&P 500 because it has done well.
Japan's Nikkei 225 index between 1957 and 1989 provides a lesson. It went up over 8000% which was an average annualised return of 15% over a span of 32 years. By 1989 confidence was sky high in Japanese manufacturing. The Japanese stock market was larger than the US, dwarfing the 7% returns from the S&P500 over the same period. It was seen as a very 'safe' investment with such a long history of strong performance. No one expected what happened next: an 80% peak to trough downturn which took until 2024 to reach the 1989 peak, over 30 years!! just to recover. This is not an isolated example.
There are no guarantees and people putting their life savings into any asset, oblivious to the risks makes me uncomfortable.
Survivorship bias in life
The thing I try to remember is that survivorship bias affects every area of life. Social media is obsessed with studying the micro habits or routines etc of wealthy people, celebrities, entrepreneurs, gurus, we ignore the full unconditional sample (including the failures) who also had the same work ethic, similar habits, are also talented and whatever is attributed to success in these areas with a high randomness element, who never made it.
On the flip side, does that mean we are powerless since randomness is such a deceptively powerful force? No actually the opposite, because of asymmetric outcomes, which I will write about in the next newsletter.
Make sure you look out for that in 2027. Only joking! I plan to keep roughly a bi-weekly cadence going forward.
Hit reply if you have any thoughts, opinions, especially if you disagree - I like a good discussion.
Quote
The scenes of our life resemble pictures in rough mosaic; they are ineffective from close up, and have to be viewed from a distance if they are to seem beautiful. That is why to attain something desired is to discover how vain it is; and why, though we live all our lives in expectation of better things, we often at the same time long regretfully for what is past. The present, on the other hand, is regarded as something quite temporary and serving only as the road to our goal. That is why most men discover when they look back on their life that they have the whole time been living ad interim, and are surprised to see that which they let go by so unregarded and unenjoyed was precisely their life, was precisely that in expectation of which they lived.
Arthur Schopenhauer
What I'm reading
Fooled by Randomness by Nassim Taleb
Resources
I can't believe it's taken me this long to switch to Obsidian from Notion. It's opened up a whole new way of understanding for me. It's free so check it out.
As a side note, I've started a brand new YouTube channel: https://www.youtube.com/@hans_chan
I plan to talk about a mix of finance, knowledge management, and books. If you're interested drop a follow :)
Have a good weekend.
Hans