Although there has been considerable debate over just what intelligence quotient (IQ) tests actually measure, studies have suggested that people who achieve higher scores are more likely to do well in school, earn more money and even live longer.
But does having a high IQ help when it comes to the stock market? The answer, according to a paper entitled IQ and Stock Market Participation, seems to be “yes” – with a few caveats.
A research team led by Mark Grinblatt, finance professor at University of California at Los Angeles, concluded that people with relatively high IQs typically diversify their investment portfolios more and invest more heavily in stocks as an asset class than people with lower IQ scores. People with higher IQs also tend to favour smaller-capitalization and value stocks, which tend to beat the broader market over time.
According to the research paper: “Compounded over many years, this return difference could contribute to the wealth gap between low- and high-IQ individuals to a greater extent than wage differences.”
The researchers came to that conclusion after dissecting a database of Finnish investors over a 20-year period.
Why Finland? First, Finland requires that all able-bodied young men perform mandatory military service. As a result, the researchers were able to obtain entry-level test scores for cognitive functioning in mathematical, verbal and logical skills, which were used as an indicator of IQ.
Second, all Finnish taxpayers are required to report their investment portfolios to the government as part of their annual tax filings.
The researchers then took these IQ scores and compared the investment results the conscripts – most of whom were about 19 or 20 years old at the outset – were able to achieve after they had completed their tour of duty.
The researchers didn’t find that subjects with higher IQ scores were blessed with any particular stock-picking prowess, but they were more likely to construct portfolios with better risk/return profiles than their lower-scoring peers.
Low-IQ investors tend to make more mistakes, the research suggests, which often deters them from further participation in the stock market. At the same time, members of this group fail to diversify their portfolios, are less likely to include mutual funds and tend to be attracted to big-name stocks that are making headlines.
High-IQ investors are more successful because they moderate their risk with better diversification and maintain broader exposure to stocks of all types.
Unfortunately, the study doesn’t take into account whether the latter group subsequently invested in other asset classes that might prove equally attractive, such as bonds or commodities. As well, no women were included in the sample.
In a followup study using the same data, entitled IQ and Stock Market Trading, the researchers also concluded that high-IQ people are less subject to the “disposition effect,” which suggests that investors are predisposed to holding losers too long and selling winners too early.
High-IQ investors also are more aggressive when it comes to tax-loss trading, which is generally perceived to be a sophisticated strategy.
The bottom line: the smarter your clients are, the more likely they are to invest in the stock market. Whether they’ll be any good at it probably is up to you.IE
© 2013 Investment Executive. All rights reserved.