Being smarter means a better investing experience
A recent study examined the connection between IQs and investing experiences. Not surprisingly, the authors found that people with higher IQs tend to do better in most areas of investing.
The authors of the study "IQ, Trading Behavior, and Performance" examined two decades of scores from an intelligence test administered to nearly every Finnish male of draft age. They then used a comprehensive data set to determine if IQ correlates with returns. Here's what they found:
Trading Appropriately
High-IQ investors are less subject to the disposition effect, which causes investors to sell their winners while keeping their losers. The disposition effect leads to realizing gains on winning stocks and trades against momentum, which can reduce returns. On the other hand, high-IQ investors are momentum investors, tending to buy stocks that performed relatively worse in the past month and relatively better in the past year. Given the large momentum premium, high-IQ investors benefit from this pattern.
High-IQ investors are also more aggressive about locking in tax losses while being patient enough to trade when they might get a liquidity premium, or additional returns that can be had by selling when everyone else is buying and vice versa.
Timing Purchases
High-IQ investors exhibit superior market timing, buying when valuations are low and avoiding buying when they're high.
High-IQ investors' aggregate stock purchases subsequently outperform low-IQ investors' purchases, particularly in the near future. This performance isn't offset by larger transaction costs: The purchases and sales of high-IQ investors are executed at better prices and at better times than low-IQ investors' trades.
High-IQ investors' stock picks and execution skills result in a 2.2 percent per year spread between the portfolio returns of high- and low-IQ investors. This 2.2 percent spread ignores differences in market timing arising from moving cash into and out of the market. The spread jumps to 4.9 percent per year when IQ-related differences in market timing are accounted for, including the tendency of high-IQ investors to avoid market participation when returns to stock investing appear to be low.
It shouldn't be surprising to find that high-IQ investors are more aware of the academic research on investing. Thus, they benefit not only from superior diversification, superior trade execution, superior tax management and fewer behavioral biases, but also from gaining exposure to the premiums available from the small-cap, value and momentum factors. And they also buy lower cost index funds.