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A recent paper published by a team of international academics links IQ to successful investing. The authors, Mark Grinblatt of UCLA, Juhani Linnainmaa of the University of Chicago, and Matti Keloharju of Aalto University in Finland, concluded that people with higher IQs tend to participate in the stock market more often, hold more diversified portfolios, and earn higher risk-adjusted returns than their lower IQ cohorts. Seeking Alpha is a site dedicated to making its readers more intelligent investors, so examining how the more intelligent members of a society are able to earn higher returns on their money seems like a more than worthwhile exercise.

While it makes intuitive sense that gains accrue to smarter investors at the expense of weaker investors in active investment management, empirical evidence attesting to this fact is difficult to come by. How smarter investors are able to glean higher market returns would be important information for all market participants. The authors took their research on these questions to Finland to find answers. Why examine a country with roughly the population of Minnesota? Three reasons: military service is compulsory in the sparsely populated Nordic nation, and I.Q. test scores are available for all conscripted males in the country; the nation has a wealth tax that requires its citizens to report their investment portfolios to the government; and, authors Linnainmaa and Kelohrju share a Finnish heritage. These factors combined to form an expansive dataset to test the linkage between intelligence and investing.

Of course, intelligence is linked to many other factors including income, quality and extent of education, and family upbringing. The authors attempted to control for these variables to more directly link intelligence and investment performance. The results are astounding. When IQ's are distributed into cohorts ascending by relative score, stock market participation is linked monotonically to IQ. Individuals with the lowest IQ scores invest least; the second lowest IQ cohort invests the second least, and so forth. In every below average IQ cohort, non-participators exceeded market participants, while in every above average IQ cohort, market participants were more prevalent than non-participants.

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Controlling for educational attainment, birth year, income, wealth, occupation, native language, marital status, and employment status, the coefficients related to IQ were strikingly significant because of both their magnitude and ordinal relationship. The IQ effect is more closely linked to stock market participation than even income, which indicates cognitive ability is a larger barrier to participation than available funds. Wealth, controlling for the same variables, is more significant than IQ in predicting stock market participation, but given the performance of Finnish stocks in the 1990s, the wealth factor could be the result of participation and not a causal factor.

The study also documented that low IQ investors are likely to experience a more adverse risk-return tradeoff than the higher IQ cohorts due to inferior diversification. High IQ individuals were more likely to hold a greater number of stocks and diversified mutual funds, with mutual fund ownership again increasing monotonically with IQ. Higher IQ cohorts were also more likely to pick value stocks and small cap stocks, which academic literature has shown outperform high growth stocks and large cap stocks respectively when adjusted for risk.

Including direct investing and indirect investing through retirement accounts, only roughly half of Americans own stocks. While low wealth levels account for some of the non-participation, there is still a considerable amount of the populace with the means to save who do not invest. With the emergence of discount online brokers, and the ubiquity of low cost index funds, the barrier to stock market investment has probably never been lower, but a considerable proportion of our society does not invest in the stock market. With non-participants earning lower returns on their savings than market participants over time, the divergence between low IQ and high IQ cohort's wealth will diverge over time. These findings have important policy implications given the growing gulf between the poor and wealthy in our society. Perhaps increased education on financial markets in primary school could lead to a higher proportion of investors in society over time. A rise in stock market participation could offset some of the downward pressure on stock ownership predicted by the demographic composition of our aging population.

Source: Does Greater Intelligence Equal Greater Investing Returns?