How Selection Bias Can Ruin Your Retirement

Even if you’ve never heard the term selection bias, you likely already have a grasp of what it means. It’s a staple of our current culture and social media use. People love to post pictures from their great vacation or fancy restaurant meal, but rarely do you see the bill. Cute kids and sleeping dogs are also more fun to share than their crying and barking alter egos. This can easily lead to the idea that other people are living some perfect life, devoid of the challenges that we all face. Therein lies the bias. You only see the selected information instead of the full data set.

Don’t get me wrong. I’m not here to complain about people posting happy events from their lives. This type of selection bias is part of human nature. It’s more fun to share good news than bad. I try to provide a balance between the positives and negatives of our alternative lifestyle in my writing, but I’m sure I’m also guilty of skewing towards the positive. I’m much more inspired to write posts when exciting and interesting things are happening. Sitting around being bored because I can’t travel anywhere doesn’t lend itself to a post. It’s important to realize that this bias exists, whether you’re scrolling Instagram, reading blog posts, or making investments.

I was inspired to write this after seeing a very unfortunate situation posted on a Reddit FIRE sub. During the recent Gamestop (GME) short sell squeeze, this person went all in and ended up losing way more than $350k. I don’t know how much more, only that he started with $350k and is now “negative in a big way”. It immediately dawned on me that I almost never see posts like this. Who would want to share this kind of crushing defeat with the world and take the related abuse? It’s much easier to stay silent and lick your wounds. 

This guy had saved up $350k before age 30 and was well on his way to a very early retirement. With such a great start, why gamble? The reason is likely very simple. He saw others presumably making huge returns and thought that it would be simple to do the same. Anyone who reads post after post of people making easy money is bound to be tempted to follow suit. However, he failed to recognize the inherent selection bias in his data set. 

Hundreds of posts flooded the internet bragging about huge returns when the Gamestop news first broke. They all made it seem like it was a sure thing. It can be hard to watch everyone else making huge gains while you’re sitting on the sidelines giving up that “free money”. But it only seems like that’s the case because of carefully selected reporting. Posts of people making large gains are not representative. Missing from the data set are the thousands of people losing money after attempting the same thing.

The lack of posts about money being lost made it seem like everyone was winning. That’s obviously not even close to reality, but I’m sure it felt that way at the time. He let greed get the best of him and opted for a get rich quick scheme over a hard work and perseverance strategy. And now he’s starting over after blowing up his previously enviable position.

Ignoring selection bias meant not recognizing the true risk involved. The vast majority of people lose money when trying to day trade or play with options. In fact, I would wager that more money is made selling naive people courses on how to day trade than is made through actual day trading. Treating the stock market like a casino means that you’re going to get similar results. A handful of people win big, but most lose.

This is obviously an extreme example and most people stay away from options and margin trading. But that doesn’t mean that investors aren’t influenced by selection bias on a smaller scale. Hang around any investment forum and you’ll find it’s filled with posts of people bragging about their huge gains from picking stocks. They love to tell others about how they bought [the next hot stock] and the big returns they’ve made because of it. Almost never do you see anyone’s entire portfolio though. Everyone is going to have losers too, even though they somehow always fail to mention them. 

And returns alone are not enough to make a fair comparison. A post from someone bragging about buying a hot stock in 2015 with a 75% gain makes it seem like a really good pick. That’s until you compare it to the S&P 500 and see that between March 2015 and March 2021 the S&P returned 85%. So that great stock pick trailed the broad market by 10%. Very few people follow through with making the comparison though, so they often have no idea how well they are performing. They just know their pick went up a lot.

It’s also easy to mistake luck for skill. Even with picks that beat the indexes, it’s impossible to know if your “due diligence” made any difference at all. After all, there are over 3500 stocks in the US stock market. Choosing 30 of them, even at random, could outperform the entire market. If a monkey throwing darts can consistently beat trained professionals, there’s a chance you can too. But even if you do outpace the broad market returns for a time, it’s entirely possible that it was just luck. Is luck something you want to stake your retirement on?

There are people who hit the jackpot at the casino every day. Lotto winners are shown holding giant checks every week. For every brag post online about 100%, 1000%, or even 10,000% returns, dozens of people lost their money or received subpar returns. It’s only because of selection bias that it feels like everyone is getting rich quickly. But think about it. If giant returns were common, no one would brag about it.

Despite what you may see from self-selected braggards, using options, margin, or even trying to pick winning stocks is a losing strategy on the whole. If you hopped on (or were tempted to hop on) the GME bandwagon, then taking some preventative steps now can help when the next “sure thing” comes along. I’d recommend writing an Investment Policy Statement. Then if you get the urge to buy options, use margin, or even simply purchase shares of the next “can’t lose” stock, you can pull it out and read it. If there’s no section that mentions gambling away your retirement money, then you know to avoid it and keep on your steady path. Index funds may not be exciting, but they sure are effective.

It’s like your mom (probably) used to say. If everyone else jumped off a bridge, would you do it too? In this case though, it only seems like everyone is on the bridge. The reality is that most of us are watching safely from the shore. It’s just that no one is looking towards us, so it seems like we’re not there. Join us where it’s safe. Don’t let this sort of selection bias ruin your retirement too.