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Who needs brains?

Created:

15 January 2010

Written by:

Chris Dillow

Do investors need brains? A new study sheds light upon this question. It took place in Finland, which has two features which allow this issue to be tested. First, all Finnish men get an IQ test in early adulthood, when they are conscripted. Secondly, all households' equity trades are recorded on a central database.

This allows the question to be answered: do high-IQ investors make more profits than low-IQ ones? A team of researchers led by Mark Grinblatt of the University of California Los Angeles have run the numbers.

They conclude: "High IQ investors' stock purchases subsequently out-perform low IQ investors' purchases by an economically and statistically significant margin." In particular, shares bought by the 4 per cent of investors with the highest IQ out-performed those bought by the 40 per cent with the lowest IQ by 8.8 basis points (0.088 per cent) in the two days after purchase. This is an annualized out-performance of over 11 per cent. This controls for the obvious risk factors that might cause a share to out-perform, such as its beta, value or momentum.

Impressive? Well, no. For one thing, the out-performance comes only in buying shares. Stocks sold by high-IQ investors subsequently do no worse than those sold by dummies. Intelligence doesn't help investors know what or when to sell.

Also, it's not clear that this short-term out-performance can be annualized. The only sure way of doing so would be if there were 130 successive two-day trades of such profitability. But it's not obvious that there are. This matters, because over longer holding periods, the stocks bought by high-IQ investors do less well. At monthly horizons, their out-performance is only half a basis point, which is practically nothing.

It seems, then, that intelligence only helps traders spot fleeting opportunities; the researchers also find that smarter traders deal on better bid-offer spreads. It doesn't help us identify longer-term opportunities.

We could speculate as to why this should be. One possibility is that in investing - as perhaps in other walks of life - IQ is over-rated. Successful investors need experience (but not age!), nous and discipline. The link between these and IQ is weak.

Or it might be simply that markets are largely efficient, in the sense that there are just not many profitable opportunities of the sort which can be spotted by raw intelligence. If there are no fish in the lake, it doesn't matter how good your tackle is.