Robert Shiller, professor of economics at Yale, recently wrote an article about a study in the Journal of Finance that showed high-IQ investors tend to outperform low-IQ investors.
The study can be summed up to some extent in this line from the study itself:
“Lack of cognitive skill is so fundamental as a driver of nonparticipation that it deters large amounts of wealth from entering the stock market.”
The bottom line is that those with higher cognitive ability tend to participate more in the stock market, as illustrated below:
(Please forgive my lack of artistic ability and accuracy.)
What’s astonishing is that external factors in the study such as wealth, income, age and occupation were controlled for. Participation rates are just higher for those with higher IQs, period.
Even more importantly though, the study goes into the decisions made by those with higher IQs and finds that their investment decisions are much better than those with lower IQs as well. What did they find?
- Diversify their portfolios more.
- Favor small capitalization and value stocks.
- Favor high book value in relation to market price.
- Are more likely to hold mutual funds.
- Hold larger numbers of stocks.
- Have lower-beta portfolios.
(These findings corroborate much of the information you’ll find in the education section of my website.)
In the “conclusion” section of the study some other important findings (such as those from other studies) are noted:
“While we have not fully resolved the participation puzzle, our results suggest the intriguing possibility that the odds are stacked against low-IQ investors when they do participate in the financial markets. Calvet et al. (2009) show that investors who make some investment mistakes tend to make many of them. Grinblatt, Keloharju, and Linnainmaa (2011) document that high-IQ investors’ stock purchases earn larger risk-adjusted returns, that their purchases and sales experience lower trading costs, and that their trades are less subject to profit-eroding behavioral biases like the disposition effect. Grinblatt, Ikaheimo, Keloharju, and Knupfer (2011) observe that high-IQ investors pay lower effective mutual fund fees by constructing “home-made balanced funds,” that is, portfolios of equity and bond funds.”
So does this mean you’re doomed to poor performance if you have a low IQ? Not necessarily. It just means that investing in the stock market might be more of an uphill battle for you. However, if you understand the reasons why high IQ investors tend to perform better and emulate those same characteristics there is a high probability that you will also do well in the stock market. However, it might not hurt to take an intelligence test just to see where you stand.