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Tuesday, February 28, 2012

High-IQ Investors

I have to say that, in my experience, some of the smartest people I have ever met have been the lousiest investors.  In fact, the only thing that has saved them has been their high incomes.  They anaylze individual stocks and find it hard to believe that what they have learned the market already knows and is reflected in the price of the stocks, are absolutely adamant about the direction of the market, and tend to chase the hottest performing sectors, and get caught up in bubbles because bubbles tend to reinforce their belief in their own genius.  But my data set isn't that large, so I'll defer to a fascinating study by Mark Grinblatt of the University of California, Los Angeles, Matti Keloharju of Aalto University in Helsinki and Juhani Linnainmaa of  the University of Chicago, What High-IQ Investors Do Differently, described by Robert Shiller.

The study is based on data from Finland where young men are required to serve in the military and, thereby, are given IQ tests.  Finland also has a wealth tax which requires investment portfolios to be  reported.  According to Shiller, the researchers find that the propensity to follow accepted portfolio techniques--diversify, invest in low cap stocks, etc.--is greater for higher IQ men (it seems that females may have been skipped in this study!).  Interestingly, nothing is reported, as far as I can tell, on performance, which of course would be the bottom line!

Shiller goes on to say that the bigger issue might not be intelligence per se but a lack of trust.  The ability to learn who to trust though, according to Shiller, is dependent on intelligence.  He cites a second study that found those with a "high level of trust" were more likely to invest in the stock market.  To me, this is a sort of "duh!" finding.

I am a huge fan of Shiller and have admired his books and especially the research he has done on the p/e ratio.  I believe it is useful for determining entry points for long-term investing.  Still, I have some difficulty with statements he makes. For example, he says
 Successful investing requires that we judge other people, and it relies on an ability to develop a good model of others’ minds.
Frankly,  I'm not even sure what the last part of the sentence means.  My main beef, though, is that just investing in the market with a well-diversified portfolio comprised of low-cost funds has been very successful over the long run.  In fact, voluminous evidence supports the finding that it outperforms 70% to 80% of all professionals after all costs are accounted for!  There is no need to "...judge other people."  More than anything, it requires a belief that the economic system will continue to produce remarkable products.  In a world where the information available to geniuses with a laptop is proliferating at an amazing rate, I believe it is a belief that is easy to accept.

I  would like to see a study on how much wealth has been lost because people went to Mr. High IQ for investment advice!


  1. I think active investing depends more on knowing your emotions rather than your IQ. I think that's probably what Shiller is trying to imply.

  2. I'm still trying to figure out what he is trying to imply. I enjoy his work and the ongoing debate between him and Jeremy Siegel. Shiller obviously believes in market timing based on valuation. His P/E ratio work has led him to believing the market has been over valued. As a result he has missed the rally and I thing this is a potential shortcoming of his approach. Analysts who say stay away from stocks because the market P/E is 18 and the average is 14 miss the possibility that it can go way above the average - to say 23. In this case they miss a significant multi - year rally.
    I saw this happen in the early '80s as investors waited for single digit P/Es.
    Again, I think he is one of the most brilliant analysts around and enjoy following his work. And who knows - in the long run he may be right with his market call.

  3. I am so with you. It is actually disappointing that they didn't look at performance. Of course, trust in the system is needed. Trust in individuals, I guess, could be important if you use a traditional broker, but so many of us are going it alone today so that that comment seems out-of-date or limited in scope compared to reality. Will high IQ be correlated with success? I suspect the results will be surprising once you really dig into the data and account for confounders, such as social intelligence, familial support, and the quality of education.

  4. Look at that last 10 years of Bill Miller....... the hubris of high IQ.

  5. I can never understand why theirs so many smart people in the securities business. Yes theirs a lot of information to digest but most of the stuff is far from einstein material. You would think many of these folks would get bored with all this stuff after a while. I know this because I was one of the worst student in school but finaicial stuff is just not that complex to learn because I have learned a lot about investment finance over the years. If you just make a small effort. Compare learning to speak russian fluently and write in russian at a twelfth grade level now thats a real intellectual challenge' to learning about basic investment finance reading a companies balance sheet and other financial statments learning about exchange traded funds fixed income investments and so forth now thats really not a intellectual challenge when you compare it to learning russian. If you just break it down financial stuff a little its really not that hard compared to learning to speak russian fluently.