The Poor Investor

Investigatory Value Investing

Tag Archives: iq

Who You Know or What You Know?

I’ve recently finished my MBA and am now searching for employment opportunities. In this search I’m reminded, quite starkly, of the oft-quoted phrase, “It’s not what you know, it’s who you know.” The great thing about the stock market is that it works in exactly the opposite way. In the stock market, it’s not who you know that matters but what you know. The market, as Ken Fisher puts it, is “The Great Humiliator” and does not care who you are or who you know, “it wants to humiliate everyone.” In fact, who you know often works against you and may even entice investors towards illegal activities, as exemplified recently by a few well-known individuals.

The “what you know” I’m referring to here is your own analysis of individual companies and the markets in general. In fact, if you would have listened to common wisdom (the “who”) you might have sold in May, went away and missed out on a 2.1% gain in the S&P 500. You might have missed the boat on Apple at around $427 a share when everyone was claiming the sky was falling only to watch it rise to $633 a share, a lost opportunity of $206 per share. Once, when I was new to investing, I told a friend not to invest in Sirius XM when it was trading around $0.30 per share and he missed out on a potential 10-bagger. Or, you might have listened to friends who told you to buy Facebook when it first went public at $38 per share only to watch it drop to $18 in the first three months.

Nothing works better in investing than coming up with your own conclusions. For one, you won’t have the conviction in the company you are buying if you go based off of someone else’s recommendation. Even if someone is spot on about a company’s valuation and tells you that company X will go from $5 a share to $15 a share—even if this person is absolutely right and has a compelling enough reason— are you going to be able to hold the company’s stock when it goes from $5 a share to $1 a share before it goes up to $15 a share? Will you really have that level of discipline and, more importantly, trust in someone else’s judgment? Only by doing your own analysis, coming up with your own valuation and buying a company that you have strong conviction in because you put in the hard work will you be able to hold through the downs (or buy more) and not sell too early during the ups. This person’s recommendation may be 100% accurate but you might be enticed to sell at $7 for a $2 gain because you just won’t have the commitment you would have had if you came up with the idea in the first place.

Secondly, if your investment is in a company someone else recommends, you probably won’t have any idea of what to look for when things are going south. Are insiders selling? Did a member of management leave? Is this good or bad? How do you know if you didn’t investigate the company thoroughly? Now, say, the company has to raise funds by issuing stock— is this good? Was this part of the company’s plan all along? If you weren’t following the company, if you didn’t do your homework, you wouldn’t have any idea on these questions or any others. There won’t be any tip-offs to tell you when things are going well or if the management is running the company into the ground when you don’t put in the long hours of work it takes to investigate a company thoroughly enough to have conviction in it.

These are just a few of the reasons why you need to think for yourself when it comes to investing. This is why I don’t like recommending companies, it takes away from a core part of what will make someone a successful investor. I like to use companies as examples to illustrate ideas and how to think about companies, not as advice for what to buy. And with that, I will leave you with a quote from the Oracle of Omaha himself:

“You have to think for yourself. It always amazes me how high-IQ people mindlessly imitate. I never get good ideas talking to other people.”  -Warren Buffett


IQ and Successful Investing

Robert Shiller, professor of economics at Yale, recently wrote an article about a study in the Journal of Finance that showed high-IQ investors tend to outperform low-IQ investors.

The study can be summed up to some extent in this line from the study itself:

“Lack of cognitive skill is so fundamental as a driver of nonparticipation that it deters large amounts of wealth from entering the stock market.”

The bottom line is that those with higher cognitive ability tend to participate more in the stock market, as illustrated below:

(Please forgive my lack of artistic ability and accuracy).

What’s astonishing is that external factors in the study such as wealth, income, age, and occupation were controlled for.  Participation rates are just higher for those with higher IQs, period.

Even more importantly though, the study goes into the decisions made by those with higher IQs and finds that their investment decisions are much better than those with lower IQs as well.  What did they find?

High IQ Investors:

  • Diversify their portfolios more
  • Favor small capitalization and value stocks
  • Favor high book value in relation to market price
  • Are more likely to hold mutual funds
  • Hold larger numbers of stocks
  • Have lower-beta portfolios
(These findings corroborate much of the information you’ll find in the education section of this website).
In the “conclusion” section of the study some other important findings (such as those from other studies) are noted:
“While we have not fully resolved the participation puzzle, our results suggest the intriguing possibility that the odds are stacked against low-IQ investors when they do participate in the financial markets. Calvet et al. (2009) show that investors who make some investment mistakes tend to make many of them. Grinblatt, Keloharju, and Linnainmaa (2011) document that high-IQ investors’ stock purchases earn larger risk-adjusted returns, that their purchases and sales experience lower trading costs, and that their trades are less subject to profit-eroding behavioral biases like the disposition effect. Grinblatt, Ikaheimo, Keloharju, and Knupfer (2011) observe that high-IQ investors pay lower effective mutual fund fees by constructing “home-made balanced funds,” that is, portfolios of equity and bond funds.”
So does this mean you’re doomed to poor performance if you have a low IQ?  Not necessarily.  It just means that investing in the stock market might be more of an uphill battle for you.  However, if you understand the reasons why high IQ investors tend to perform better and emulate those same characteristics there is a high probability that you will also do well in the stock market.  However, it might not hurt to take an intelligence test just to see where you stand.
—-Written by: The Poor Investor
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