Smarter People Own More Stocks

 
Business Times - 26 Jan 2012

Smarter people own more stocks, says study
It finds a direct link between IQ and market participation

( NEW YORK ) The smarter you are, the more stock you probably own, according to researchers who say they found a direct link between IQ and equity market participation.


Intelligence, as measured by tests given to 158,044 Finnish soldiers over 19 years, outweighed income in determining whether someone owns shares and how many companies he invests in. Among draftees scoring highest on the exams, the rate of ownership later in life was 21 percentage points above those who tested lowest, researchers found. The study, published in last month's Journal of Finance, ignored bonds and other investments.

Economists have debated for decades what they call the participation puzzle, trying to explain why more people don't take advantage of the higher returns stocks have historically paid on savings. As few as 51 per cent of American households own them, a 2009 study by the Federal Reserve found. Individual investors have pulled record cash out of US equity mutual funds in the last five years as shares suffered the worst bear market since the 1930s.

'It's what we see anecdotally: higher-IQ investors tend to be more willing to commit financial resources, to put skin in the game,' said Jason Hsu, chief investment officer at Research Affiliates. 'You can generalise a whole literature on this. It seems to suggest that whatever attributes are driving people to not participate in the stock market are related to the cost of processing financial information.'


Mark Grinblatt of the University of California , Los Angeles , Matti Keloharju of Aalto University in Espoo and Helsinki , Finland , and Juhani Linnainmaa at the University of Chicago compared results from intelligence tests given by the Finnish military between 1982 and 2001 to government records showing investments the draftees later held. They found the rate of stock ownership for people with the lowest scores trailed those with the highest even after adjusting for wealth, income, age and profession.

While intelligence influenced things that might naturally increase equity ownership such as wealth and income, the authors said IQ determined who owned the most stocks within those categories as well. Among the 10 per cent of individuals with the highest salary, 'IQ significantly predicts participation' in the stock market, they wrote.

For example, people in the highest-income ranking who scored lowest on the test had a rate of equity market participation that was 15.7 percentage points lower than those with the highest IQ.

'If you look at the significance of IQ related to other factors like income or wealth, certainly it plays a very large role,' Mr Keloharju, a finance professor at Aalto, said. 'It's very difficult to get around that problem, but the results are so strong here. We are playing with lots of different controls and lots of different specifications, and all the time things work really well.'


American economist Harry Markowitz won a Nobel Prize in 1990 for his theory that owning a larger variety of assets tended to maximise returns for a certain amount of risk. The 2009 study by the Fed found that 51.1 per cent of American families own stocks directly or indirectly, and of those who do, 36 per cent have shares in one company.

'It's difficult to justify why someone wouldn't invest in the stock market, knowing what a good deal it has been,' said Mr Linnainmaa, a co-author of the study from the University of Chicago's Booth School of Business. 'The classical explanations for non-participation have been participation costs. It's not just that it may be expensive to buy stocks and mutual funds, but people may not have enough knowledge about them.'

Finnish soldiers were an ideal sample because differences in race, schooling and market access are minimised, the authors said. Draftees were about 20 years old when they were given 120 questions in math, language and logic. The authors divided the results into rankings and compared them with stock ownership records. People who don't serve in the country's military such as women weren't in the sample.

'There is an older literature on whether SAT scores of an investment manager's college helps predict his or her success,' Robert Shiller, an economics professor at Yale University and co-creator of the S&P/Case-Shiller home price index, said in an e-mail. 'This paper has a much better measure of intelligence,' and the 'results are therefore a significant advance', he wrote.

Finnish draftees aren't representative of typical investors, said Brian Jacobsen, chief portfolio strategist at Wells Fargo Advantage Funds. IQ is a function of culture and shouldn't be generalised across borders, he said. The authors also failed to discuss whether the test given to the soldiers was a valid way to grade thinking.


Finland's lack of ethnic diversity 'invalidates it for extrapolating it to other cultures', he said. 'That makes it that much more inappropriate to draw inferences from it about other cultures.'

The study's authors said the findings have implications for social policy. Avoiding stock investments cuts returns and may widen income gaps, they said. Individuals scoring lowest on the tests who still owned equities earned as much as 33 basis points, or 0.33 percentage point, a year less than the highest scorers. One way governments could promote better savings might be with plans that let people opt out of stocks, like 401(k) plans, as opposed to opting in, said Mr Keloharju.

'If you look at these people over time, people with higher IQ scores and stocks become wealthier and wealthier at a much faster rate than people with lower IQ scores,' said Mr Linnainmaa. 'It makes them worse off in the long run, even more so than the difference in income.'

Mr Hsu of Research Affiliates said an explanation for why draftees with lower test scores owned less stock is that they found it harder and more expensive to receive financial education. Getting people information on investing at a younger age may help limit the disparity, he said. -- Bloomberg