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ETF Specialist

Survivorship Bias

Surviving funds can overstate a category's performance.

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Many funds that were around 20 years ago no longer exist. Not surprisingly, the funds that closed tended to have relatively poor performance. Fund companies have a habit of merging losers with better-performing funds, which allows them to keep their clients' assets and mask poor performance.

The average return for all mutual funds currently in the large-blend category was 8.9% annualized over the trailing 20 years through March 2014. While this statement is accurate, it overstates the performance of the average large-blend fund that existed 20 years ago because it excludes the performance of funds that did not survive the period; this phenomenon is known as survivorship bias. Additionally, some of the funds currently in the large-blend category may have been in a different category 20 years ago. This is called look-ahead bias. Look-ahead bias can occur when a fund's category is changed but those changes were not known at the beginning of the time period.

Michael Rawson does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.