Thursday 7 January 2021

Nostalgic research: Do Smart Investors Outperform?

The next installment in our Nostalgic Research series is ‘Do Smart Investors Outperform Dumb Investors?’, published in 2009.

Due to the financial crisis caused by the covid-19 pandemic, many individuals began to invest in equities for the first time in 2020. According to Bloomberg, trading by individuals accounted for a greater chunk of market activity than at any time during the past 10 years. They were likely lured by the plunge in the prices of blue- chip stocks in sectors such as energy and financials. Months on, individual investors are likely to continue to test their luck in the markets. This bears the question: what makes a good investor?

The research published by Mark Grinblatt (UCLA), Matti Keloharju (Helsinki School of Economics), and Juhani Linnainmaa (University of Chicago) analyzes whether high IQ investors exhibit superior investment performance. It combines equity return, trade, and limit order book data with two decades of scores from an intelligence test administered to a sample population in Finland. Controlling for wealth, trading frequency, age, and determinants of the cross-section of stock returns on each day, they find that high IQ investors exhibit superior stock-picking skills, particularly for purchases, and superior trade execution for both purchases and sales.

“The behavioral finance literature finds that individual investors, on average, make major investment mistakes. They under-participate in the stock market, grossly under diversify, enter wrong ticker symbols, buy index funds with exorbitant expense ratios, and lose when actively trading in the stock market.

However, a more nuanced and less gloomy portrait emerges when we focus on the heterogeneity of individual investors. Several studies uncover a minority of individual investors whose trades systematically outperform the market and some research establishes that this performance correlates with experience.

Employing IQ measures for a large population of investors, we uncover a connection between intellectual ability and skill at both picking stocks and mitigating trading costs. High IQ investors’ purchases are informative about future stock price movements.”

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