Wall Street and the hedge fund industry are dominated by highly intelligent people with long lists of qualifications. In an environment where only the most intelligent survive, entering an industry like Wall Street with high-level qualifications makes sense. Unfortunately, this disqualifies most individuals from joining this exclusive club.
However, according to the Oracle of Omaha, Warren Buffett (Trades, Portfolio), having a low or average IQ can actually be an advantage for investors, and simply having a high IQ in and of itself does not mean that one will be successful as an investor.
The benefits of the average investor
At the 2002 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual meeting, Buffett was taking questions from shareholders when one shareholder asked if he could provide some insight into how the terrorist attacks on 9/11 had impacted insurance rates.
Insurance and investing have a lot in common. Insurers should only take on risk, or insure a risk, when the price is right and provides suitable compensation for the risk involved.
Successful investing involves buying securities at a discount to their intrinsic value. To put it another way, investors should buy stocks when the price provides a suitable level of compensation for the risk involved.
This is where insurance and investing overlap. In 2002, Buffett said they had another thing in common as well, the need not to have a high IQ:
"The most important thing in investments is not having a high IQ, thank God. I mean, the important thing is realism and discipline. And you don't need to be extraordinarily bright to do well in investments, if you are realistic and disciplined."
He went on to add that it is the same in the insurance business. Figuring out the correct price for a risk is not some ancient science, he stated. One does not need to be a mathematical genius to calculate the right price for the level of risk involved.
Instead, one needs a strong understanding of the probabilities and risks involved. If one has an understanding of these factors, it is possible to price risk with "a good understanding of arithmetic and an inherent sense of probabilities."
It might seem strange to see one of the most successful investors in the world claim that investors do not need a high IQ to be successful. However, as Buffett went on to explain, he and his partner, Charlie Munger (Trades, Portfolio), have gained an edge over the market in the past by staying within their circle of competence and trying not to do anything stupid:
"As Charlie says, to the extent that — I think we've always, from the investment standpoint, you know, if we've had any distinguishing characteristics, it would be that, in terms of realism and discipline. And generally that means finding what you don't know. In insurance underwriting, it's the same thing. You have to have — you have to be realistic about what you can understand and what you can't understand, and therefore, what you can insure and what you can't insure."
Unfortunately, while Buffett seems to believe a high IQ is not required to be a successful investor, he does think investors need to understand realism and indiscipline. This is harder than it looks.
Distinguishing what you do and don't know is incredibly challenging. It requires a higher level of emotional intelligence to take a step back and say, "I don't understand this, I am going to stay away." Not all investors have this skill.
This is Buffett's edge. He might not believe that he has the highest IQ in the market, but he does have a high level of emotional intelligence and restraint. That is what really matters. Most investors lack these key qualities, and rather than trying to improve their knowledge, it might be better to focus on these traits over anything else.
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