Survivor Bias
Lotteries are a tax on the poor and stupid. Wall Street? A tax on the rich and stupid.
Calling the rich 'stupid' feels off. After all, success in America is usually tied to IQ and grit. That’s good—we want smart, driven people creating things we rely on: smartphones, surgeries, and stable power grids.
For instance, your phone is the product of 7 million years of evolution. More to the point, it’s the result of 20 years of focused, intelligent minds and unbelievably long workdays. Likewise, suppose you have to undergo brain surgery. In that case, you should be grateful that our fairly meritocratic society has determined that the smartest, hardest-working doctors endeavor to save your life, rather than apparatchiks appointed by the Comintern.
So, how is it that these same smart, disciplined people—who build tech and perform miracles—keep burning cash in active funds with worse returns than plain index funds?
The reason the wealthy keep throwing money at Wall Street, like coal into the Titanic’s boilers, is that they don’t understand the concept of Survivor Bias.
The best way to explore this notion is with a historical example. During World War II, the Navy needed to determine where its aircraft required the most armor. It’s a vital tradeoff; the more armor you have, the more unwieldy the aircraft and the more fuel you burn - a matter of life and death for the pilots. They ran an analysis of where their planes had been shot, with the results indicating that the wingtips and central body of the aircraft were the primary targets.
The Navy thought they had the answer: reinforce the wingtips and fuselage. That’s where returning planes had the most bullet holes. But Abraham Wald, a brilliant Jewish refugee rescued by America, pointed out a flaw. They were only looking at planes that made it back. The ones hit in the nose or engine never returned.
Wald realized what the establishment didn’t. The planes were getting hit in those places as well, but when they did, they weren’t making it home. What the Navy thought it had done was analyze where the aircraft were suffering the most damage; what they were doing was analyzing where aircraft could suffer the most damage without catastrophic failure. They weren’t examining the entire sample set; only the survivors were being questioned.
Wall Street celebrates the winners. The survivors. But what you don’t see are the thousands of failed funds quietly buried out of view like wrecks on the ocean floor. And yet, the money keeps pouring in, fueled by people who mistake luck for skill. If lotteries are a tax on the poor and stupid, Wall Street is a tax on the rich who never learned about bullet holes.
