In a recent two-part series, I showed that successful investment isn’t a matter of raw brainpower; instead, it’s primarily the result of refined character – and particularly of Stoic disposition. This article elaborates two related points. First, high-IQ investors don’t outperform those of average intellect. Indeed, many people – regardless of their smarts – repeatedly make basic financial mistakes; moreover, those who are seemingly astute but certainly arrogant commit the costliest errors. Secondly, and crucially, if integrity doesn’t accompany it then high IQ is a curse rather than a blessing.
What say academics?
Jay Zagorky asks: “how important is intelligence to financial success?” His research
shows that each point increase in IQ test scores raises income by between $234 and $616 per year after holding a variety of factors constant. Regression results suggest no statistically distinguishable relationship between IQ scores and wealth. Financial distress, such as problems paying bills, going bankrupt or reaching credit card limits, is related to IQ scores … sometimes increase the probability of being in financial difficulty.
Mark Grinblatt and two other academics “analyse whether IQ influences trading behaviour.” They combine “equity trade data with two decades of scores from an intelligence test administered to nearly every Finnish male of draft age” (who undergo compulsory IQ tests). “Controlling for a remarkable variety of factors,” these authors “find that high-IQ investors are less subject to , more aggressive about tax-loss trading, and more likely to supply liquidity when stocks experience large price movements.”
Terrance Odean states that Grinblatt et al provide
convincing statistical evidence that high-IQ investors make better trades than low-IQ investors. also … have better trade execution, though they do not measure the net portfolio returns of high-IQ investors, so it is difficult to know whether high-IQ investors would beat an appropriate benchmark after a reasonable accounting for transaction costs.
Odean muddles investment (the attempt to profit from companies’ long-term operations) and speculation (trying to gain from the short-term volatility of securities’ prices). But he nonetheless – and apparently unwittingly – makes a key point: Grinblatt et al. don’t conclude – since they don’t investigate – that high-IQ investors produce higher long-term returns than their average-IQ (or even low-IQ) counterparts. To my knowledge, no rigorous analysis has drawn such a conclusion. Indeed, Odean and a colleague, Brad Barber, conclude “it is safe to assume that … who trade actively in taxable accounts will earn lower after-tax returns than buy and hold investors.” (In other research, Grinblatt and his colleagues find that high-IQ investors tend to favour low-fee managed funds. This tendency, rather than any innately superior analytical ability, may improve their results compared to others’.)
Speculation, in short, and net of transaction costs, usually begets losses; consistent losses, in turn, aren’t a sign of intelligence; hence speculation – no matter how high the speculator’s IQ – isn’t smart! More generally, there’s considerable evidence (see Gary Belsky’s very readable book in the reading list) that many people – regardless of their intellect, and including high-IQ people – repeatedly make basic financial mistakes. Moreover, the more a person believes that he’s intelligent, the more overconfident he becomes. Hence two amusing ironies:
- Those who’ve convinced themselves that they’re smarter than average – whether or not they actually are – often believe dumb things and commit dim-witted acts. As George Orwell purportedly said, “some ideas are so stupid that only intellectuals believe them.”
- As I elaborated in The Australian Intelligent Investor (2005), women are less likely than men to succumb to hubris (indeed, in investing and much else they tend more towards under-confidence rather than arrogance). My hunch is therefore that, all else equal, they’re better-equipped as investors: cognitively, women aren’t innately brilliant, but are less prone than men to haughty thoughts – and therefore to stupid actions.
“Smart money” can be laughably dumb
To substantiate this first irony, let’s first define a key cliché. “Smart money,” says Investopedia, is capital
controlled by institutional investors, market mavens, central banks … and other financial professionals. Smart money was originally a gambling term that referred to the wagers made by gamblers with a track record of success. Smart money is cash invested or wagered by those considered experienced, well informed, “in-the-know” or all three. There is little empirical evidence to support the notion that smart-money investments perform better than non-smart-money investments; however, such influxes of cash influence many speculation methods.
Investopedia should add that “smart money” is often overconfident money; and arrogant speculators eventually get their comeuppance. The blunt truth is that, when it’s judged by its results, “smart money” is not infrequently dumb money. Eleanor Laise (“If We’re So Smart, Why Aren’t We Rich? The Inside Story of How a Select Group of the Best and the Brightest Managed to Bungle the Easiest Stock,” Dow Jones Newswire, 15 May 2001) provides a striking example. She profiled an investment club whose “recent record has been nothing short of a fiasco, thanks to an overweighting in trendy tech stocks and pitifully bad timing …” One of its members said “we can screw up faster than anyone else;” another, a member since the mid-1960s, described its investing strategy as “buy low, sell lower.” Over the 15 years from 1986 to 2001 – which encompassed one of the longest-ever bull markets – the club’s investments returned an average of 2.5% per year (versus, for example, the S&P 500’s 15.3% and NASDAQ’s 18.8%).
it sounds as if this group could really use an intelligent investing strategy. And that’s ironic, given who its members are. This is the Mensa Investment Club. That’s right, Mensa, the organization founded in England in 1946 with the aim of assembling the brightest Britons to advise the government in times of crisis. The cost of admission: an IQ in the 98th percentile (or better). A half-century later the organisation, which Vanity Fair once dubbed “a dating service for dorks,” has 47,000 members in the U.S. (100,000 worldwide) and one of the sorriest investment clubs you will ever see.
(I note, but don’t explore, a questionable premise that underlies Mensa’s genesis: where’s the evidence showing that high-IQ people possess special insight into, or talent for, crisis management?) The club’s chairman of stock selection and editor of its investment newsletter said: “it was my hope that a special-interest group within Mensa would have the intellect that would give us some kind of advantage.” What, then, explains the huge difference between the club members’ formidable brains and pitiable results? Laise provided a strong hint: its chairman-editor – not surprisingly, a conceited man! – has also been
a committed chartist and incorrigible techie has transformed the club … from a small-cap, value-oriented group to a highflying, momentum-buying NASDAQ nightmare. The centrepiece of his strategy is the TC 2000, a technical charting program that seems like a prop from the set of Star Trek. , “this program is the coolest thing … You can show various types of graphs and add indicators, like linear regression, moving average, Bollinger bands. Then there’s volume, stochastics, MACD, time-segmented volume, stuff like that. You can add all kinds of indicators and really confuse yourself.”
TC 2000 dictated that the club frequently change its approach to “investing.” The chairman-editor told Laise: “I keep readjusting our strategies every quarter or so … My latest is to watch the 10-day versus 40-day moving average of relative strength compared to the S&P 500.” Laise added that constant monitoring of technical price indicators led the club to trade at a dizzying rate. In 2000 it made “88 trades, or roughly one every three trading days.” In particular, it “zeroes in on trendy tech stocks with sky-high valuations.”
Indeed, the chairman-editor
touts his technical indicators on the financial Web site ClearStation, where he enjoys ruminating on chart patterns … “That’s a bullish formation,” he explains, tracing the pattern of one large dip followed by a smaller dip. “The second dip is people who bought in at the bottom, saying, ‘Oh, gosh, it’s caught back up to where it was. I want to get out here.’ Then you have everybody out who’s gonna get out based on all this dippy crap, and then you figure for all the rest of the people it’s going to be buying activity.”
How did he “analyse” stocks? Arrogantly and foolishly: “I’ll go out and see what these idiots have to say about [the chart of a stock’s price], because sometimes they’ll observe something about the chart that I didn’t see.” He admitted that he has taken some of the club’s stock picks straight from Internet message boards, and concluded that the club “is philosophical about … stock picks. The philosopher Karl Popper had the idea that we learn mainly by making mistakes … That’s been part of approach.”
The rest of us can indeed learn much from this Mensa genius – namely that some people, allegedly among the world’s most intelligent, are actually (in the sense that they proceed without a coherent or justifiable framework, and after fifteen years of failure are apparently incapable of learning from their mistakes) risibly dumb. To use an analogy from the world of computers, it’s likely that that this chairman-editor’s “chip” is very fast. But it’s certain that his operating system has been corrupted, and that severe bugs plague his analytical software. The result is not just “garbage in, garbage out” – it’s iterative erroneous miscalculation which inevitably spirals into comprehensive disaster. Unpretentious people of average intelligence (which is most people): thank heavens you’re not high-IQ and smug!
Buffett’s two-part thought experiment
In a talk to MBA students from the University of Florida in 1998, Warren Buffett presented a two-part thought experiment. “Think for a moment that I granted buy 10% of one of your classmate’s earnings.” But with this right he paired an obligation: each student must also pay to another classmate an amount equal to 10% of that classmate’s lifetime earnings.
Put yourself in these students’ position, and consider first your right to receive 10% of a classmate’s lifetime earnings. Whom will you choose? Because you’re trying to maximise your long-term return, Buffett advised that it’d be unwise to pick the person with the highest IQ:
There’s nothing wrong with getting the highest grades in the class, but that isn’t going to be the quality that sets apart a big winner from the rest of the pack. You’d probably pick the person who has leadership qualities … the person who is generous, honest and gave credit to other people for their own ideas.
Given your obligation to pay 10% of another classmate’s lifetime earnings, you’d try to minimise your outlay. What kind of person fits this bill? “You wouldn’t pick the person with the lowest IQ,” Buffett said. “You’d think about the person who … is egotistical, who is greedy, who cuts corners, who is slightly dishonest.”
Buffett has long encouraged students and investors – and people generally – to develop lists of good qualities they should inculcate and of bad ones they should suppress. His exercise is hypothetical, but it has practical – and vital – implications. Nurture the good qualities you admire. And if you examine yourself honestly and detect in yourself any of those qualities that repel you from others, strive to get rid of them. He says:
It’s simply a question of which you decide . If you write the good qualities down and make them habitual, you will be the one you want to buy 10% of when you’re all through. The beauty of this is that you already own 100% of yourself, and you’re stuck with it. So you might as well be that person, that somebody else.
Intelligence, Buffett reckons, probably won’t make or break you professionally. But integrity certainly will. When he decides whom to hire or which business or security to purchase, his decision ultimately doesn’t rest upon business metrics, and still less upon managers’ test scores or degrees. Instead, it’s all about personal character:
There was a guy, Pete Kiewit in Omaha, who used to say he looked for three things in hiring people: integrity, intelligence and energy. If they didn’t have the first, the other two would if they don’t have integrity, you want them dumb and lazy.
Honesty, Buffett emphasised on another occasion, is critical. If employees, business partners, friends, spouses, etc., “are dishonest yet hard working and intelligent they will rob you blind.”
“Stupid is as stupid does,” Forrest Gump wisely said: so judge an investor by her actions’ long-term outcomes rather than her cognitive inputs. Brainpower doesn’t foretell success; accordingly, IQ scores, advanced degrees from allegedly prestigious institutions, etc., are greatly over-rated. Whether it’s in investing or other fields, there’s no evidence – nor any logical reason to think – that people of average intelligence are at a disadvantage vis-à-vis supposedly clever people. Indeed, because they’re more likely to succumb to hubris and thus to error, high-IQ people are at a disadvantage compared to those of average aptitude.
In Rumbles Left and Right: A Book about Troublesome People and Ideas (1963), William F. Buckley famously stated:
… I should sooner live in a society governed by the first two thousand names in the Boston telephone directory than in a society governed by the two thousand faculty members of Harvard University. Not, heaven knows, because I hold lightly the brainpower … of Harvard faculty: but because I greatly fear intellectual arrogance, and that is a distinguishing characteristic of the university …
So beware: people with elevated IQ but less than high integrity may well try – consciously or not – to bamboozle you with bull-dust. And never forget that IQ is largely a matter of aptitude at logical and symbolic reasoning. Accordingly, also avoid those who possess a flair for maths but lack humility, perspective and common sense. As Benjamin Graham (“The New Speculation in Common Stocks,” The Analysts Journal, 1958) reflected,
in 44 years of Wall Street experience and study I have never seen dependable calculations made about common stock values, or related investment policies, that went beyond simple arithmetic or the most elementary algebra. Whenever is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience, and usually also to give speculation the deceptive guise of investment.
Warren Buffett concluded (Fortune 1990 Investor’s Guide):
You don’t need a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.
I’d add that the investor of superior intelligence (IQ of 120 or more) doesn’t reliably outperform one of average intelligence (85-115). When it comes to the creation of wealth, other major decisions and life more generally, high intelligence might – as long as overconfidence doesn’t accompany it, which it often does – be a nice extra. But it’s not a sufficient – or even a necessary – condition of success; and without character, it’s likely a curse.
Brad Barber and Terrance Odean, “The Behavior of Individual Investors,” Handbook of the Economics of Finance, 2013, vol. 2, pp. 1533-1570.
Gary Belsky and Thomas Gilovich, Why Smart People Make Big Money Mistakes and How to Correct Them: Lessons from the New Science of Behavioral Economics, Fireside, 2000.
Mark Grinblatt et al., “IQ, Trading Behavior, and Performance,” Journal of Financial Economics, volume 104, issue 2 (2012): pp. 339-362.
Jay Zagorsky, “Do You Have to be Smart to Be Rich? The Impact of IQ on Wealth, Income and Financial Distress,” Intelligence, volume 35, number 5 (2007): pp. 489-501.