Only half of U.S. households invest in stocks, either directly or through mutual funds, and participation in Europe is even lower. The authors of the study "IQ and Stock Participation" tried to determine if IQ played a role in determining the amount of equity participation. Sure enough, it seems the smarter you are, the more likely you are to invest in stocks.
Using a database of Finnish investors covering the 20-year period 1982-2001, the authors studied the relationship between IQ and various contributors to portfolio risk and return. The following is a brief summary of their findings:
Participation rates increase monotonically with IQ. The participation rate for individuals in the group with the lowest IQs was 21 percent lower than individuals at the other end of the IQ spectrum. The correlation exists across gender and exists even among the affluent.
More efficient investors
High-IQ investors are more likely to effectively diversify, holding mutual funds and larger numbers of stocks. Thus, they experience lower risk and earn higher Sharpe ratios, which measures risk-adjusted performance.
High-IQ investors are also more likely to hold low-beta stocks and have more exposure to small-cap and value stocks, resulting in higher Sharpe ratios.
Avoiding the markets
Low-IQ investors shun participation because they make investment mistakes -- failing to diversify properly and choosing high-beta, large-cap growth stocks, which have poor Sharpe ratios. The lower participation rate results in lower portfolio returns, contributing to the wealth gap between low-IQ and high-IQ individuals.
In a June 1979 interview with BusinessWeek, legendary investor Warren Buffett stated: "Success in investing doesn't correlate with IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people in trouble investing." I agree with Buffett that the principles of prudent investing are quite simple. I also agree with his observation that it isn't easy, because controlling emotions is difficult -- it's hard to keep your head when others around you are losing theirs. The evidence from the study "IQ and Stock Participation" provides evidence that suggests that while Buffett is correct, IQ does correlate positively with both participation rates and equity returns.