One of the holy grails of financial research is to be able to identify those traits that make for better investors.
Why?
Because if we can isolate those skills top investors have, we can strengthen our own investment activity accordingly.
A recent study looked at the connection between IQ and stock market participation.
The real results aren’t what everyone is focused on…
Building a better investor
IQ, smarts, SAT scores — they’ve all been looked at before to see if there is a connection between how smart someone is and how well they perform as investors.
So, has overconfidence, gender, and sensation-seeking behavior.
At the core of all this research is the human desire to improve our behavior (especially if money is involved!).
On Bloomberg today, Smart Money Owns More Equities:
Mark Grinblatt of the University of California, Los Angeles, Matti Keloharju of Aalto University in Espoo and Helsinki, Finland, and Juhani Linnainmaa at the University of Chicago compared results from intelligence tests given by the Finnish military between 1982 and 2001 to government records showing investments the draftees later held. They found the rate of stock ownership for people with the lowest scores trailed those with the highest even after adjusting for wealth, income, age and profession.
IQ, investors, and stock market participation
This paper, IQ and the Stock Market, which was first published in 2009, and studied young Finnish men. These guys were given quasi-IQ tests (more aptitude, really) and found that the smarter someone was, the more likely they were to hold stocks in their portfolios.
Among draftees scoring highest on the exams, the rate of ownership later in life was 21 percentage points above those who tested lowest, researchers found.
So, the first link in improving our returns over the long run has to do with stock market participation — an essential step in getting better returns is by playing the game. It’s like the old lottery joke, if you don’t buy a ticket, you can’t possible win.
If you’re not participating in the stock market, you’re not going to get the 8-10% average equity returns over the long run. That doesn’t mean you won’t make money or won’t be successful — it just means those returns won’t come via the stock market.
It’s not really IQ that drives returns
But here’s the thing — just as important is what good investors do in the stock market once they decide to participate.
We need to ask hard questions – the type of questions we deal with on Tradestreaming and my podcast:
- What do they buy?
- How do the allocate their portfolios?
- How often do they make changes?
- How much risk do they employ?
- What investing strategies do they use?
Do higher IQ people have better investing skillz? My intuition tells me not — they’re also probably overconfident.
What makes good investors is the ability to handle risk and stock to a winning strategy and see it through. This may be the most valuable fruit of an Ivy League education or high SAT or IQ scores.
Hsu of Research Affiliates said an explanation for why draftees with lower test scores owned less stock is that they found it harder and more expensive to receive financial education. Getting people information on investing at a younger age may help limit the disparity, he said.
“The costs to achieve that are certainly higher if someone isn’t providing that at an earlier stage in one’s education,” said Hsu. “If we could provide advice, or provide education, to help reduce the cost of acquiring financial knowledge, that would seem like a good thing.”
As time goes, this education gap closes. The Internet and really low cost (free?) educational tools, like Learning Markets, LearnVest, or Wall Street Survivor make learning about markets, finance, and investing accessible to everyone.
It’s education that’s the missing link — I’m sure of it. And the opportunities are just beginning to ramp. That will increase smart stock market participation and that’s a good thing for everyone in the financial food chain.
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