Tag Archives: Individual Investor

High-I.Q. Investors

The New York Times Article by Robert Schiller makes a case that high-I.Q. tend to focus on their own smaller cap stocks with value characteristics.


February 25, 2012

What High-I.Q. Investors Do Differently by ROBERT J. SHILLER

YOU don’t have to be a genius to pick good investments. But does having a high I.Q. score help?

The answer, according to a paper published in the December issue of The Journal of Finance, is a qualified yes.

The study is certainly provocative. Even after taking into account factors like income and education, the authors concluded that people with relatively high I.Q.’s typically diversify their investment portfolios more than those with lower scores and invest more heavily in the stock market. They also tend to favor small-capitalization stocks, which have historically beaten the broader market, as well as companies with high book values relative to their share prices.

The results are that people with high I.Q.’s build portfolios with better risk-return profiles than their lower-scoring peers.

Certainly, caution is needed here. I.Q. tests are controversial as to what they measure, and factors like income, quality of education, and family background may not be completely controlled for. But the study’s results are worth pondering for their possible implications.

The paper, by Mark Grinblatt of the University of California, Los Angeles, Matti Keloharju of Aalto University in Helsinki and Juhani Linnainmaa of the University of Chicago took advantage of some unusual data. The crucial numbers came from, of all places, Finland.

Why there? Two reasons. First, Finland requires all able young men to perform military service. As a result, the authors were able to obtain I.Q. test scores of all of men conscripted in Finland from 1982 to 2001.

Second, Finland had a wealth tax, and its citizens had to report their investment portfolios to the government. This means the authors could compare the men’s I.Q. scores and their investing habits, as well as link those factors to other individual data. Similar data sets aren’t available in other countries, however, so we may not want to generalize too much.

Still, the results are interesting. The authors didn’t claim that people with high scores had some kind of monopoly on stock-picking genius. What they did contend was that these people tended to follow basic rules of successful investing.

In some ways, it’s a puzzle why I.Q. scores would matter in this regard. After all, the view that people should diversify their investments, to avoid putting all their eggs in one basket, is widely accepted. It’s not hard to diversify a portfolio or to have someone do it for you.

And another time-proven rule of investing — that people should put a substantial amount of their money in the stock market — might have its detractors, no matter what their I.Q. scores. That is especially possible given the volatility in the financial markets in recent years.

Yet only about half of all American adults have money in the stock market, directly or indirectly. So maybe something else is going on. If people can’t figure out the financial markets on their own, they can entrust their money to professionals or heed professional advice. The real problem may not be that many people lack investing savvy or smarts. Perhaps what they lack is trust, or confidence in whom to trust.

Three economists, Luigi Guiso of the Einaudi Institute for Economics and Finance, Paola Sapienza of Northwestern and Luigi Zingales of the University of Chicago, argued in a paper published in 2008 that many households avoid investing directly in stocks out of vague fears that they might be deliberately misled or cheated. Using results from a survey of households, this time in the Netherlands, the economists showed that those who indicated a high level of trust were 50 percent more likely to invest in the stock market. They were also more likely to have diversified their stock holdings. The paper, titled “Trusting the Stock Market,” was published in The Journal of Finance.

Knowing whom to trust, and relying on those who are trustworthy, is itself an aspect of intelligence. Mr. Guiso and his co-authors cited research that suggested that investment decisions relied significantly on a part of the brain called the Brodmann area 10. This region of the frontal cortex is believed to be associated with our ability to make inferences about others’ preferences and beliefs based on their actions. Such social intelligence seems to reward some people more than others with an ability to put standard investment advice into practice.

Successful investing requires that we judge other people, and it relies on an ability to develop a good model of others’ minds. It requires that we put into perspective recent angry rhetoric against Wall Street and understand that, while some criticisms are surely justified, others are just as surely exaggerated.

Anyone, regardless of background or education, may worry about being misled. The professionals tell us that the stock market is the best place to invest, but such assurances don’t help us when the market swoons. Many pros assured us that housing prices would never decline, either.

But if we can somehow foster more trust in investment professionals, a full spectrum of people — whatever their I.Q.’s — might adopt a more successful approach toward investing.

THE Consumer Financial Protection Bureau, created by the Dodd-Frank Act of 2010 and now under the command of Richard Cordray, ought to be an important vehicle to help bring about such trust, by responding to complaints and making rules that will help restore confidence. The Office of Financial Education, one of its divisions, would seem to have a big role in this effort.

But there is only so much this agency can do. It has a budget amounting to less than $2 for every American adult in 2012, and much of that will go toward activities it is taking over from the Office of Thrift Supervision and other agencies.

The government, as well as those in financial and educational spheres, must think about how we can restore and strengthen ordinary people’s trust in the financial markets. It doesn’t take a high I.Q. to see that it’s in everyone’s interest to get basic financial decisions right.

Robert J. Shiller is professor of economics and finance at Yale.

Can the Little Guy Beat Wall Street?

A friend recently wrote me the following question:

Have you read the book: “The Big Short” by Michael Lewis? He is of course the author of Liar’s Poker and The Blind Side amongst others. At the end of the book a question framed in my mind that I haven’t answered yet (although I’m getting close) and I’d like to ask you. I’ll try to put it in a way that make some sense.

What is the best way for the small guy, the individual investor, to achieve great success versus the big Wall Street money machine?

Based on the individual: Is it pure and consistent value investing?

Is it disciplined technical trading?

Is it a combination of the two above?

Is it like the small individual investors I read about in this book that bought some options on the right companies at the right time and in one trade, with a defined risk, became wealthy!

They were in fact value hunters and found the LEVERAGE and DEFINED RISK of options to be a powerful tool to help them overcome what is a pretty big barrier to success and that is: consistently grinding out profits again against the Wall Street money machine. This is especially prescient of course during times of heavy market stress.

What do our individual personalities prefer? In other words what is best for me and what is best for you?

My Reply: Michael Burry is in the book, The Big Short, mentioned by my
friend. He was a self-taught investor who obviously is fiercely
independent, and he will take an extremely contrary to conventional wisdom
position. You can go to www.greenbackd.com and search for other writings by him. Also, go here to see Michael Burry’s Lecture at Vanderbilt University: http://www.youtube.com/watch?v=fx2ClTpnAAs

Michael Burry, stand outside the system: http://www.valueinvestingtv.tv/2011/02/michael-burry-wall-street-misfit-march-14-2010/

Burry is a great role model to emulate. He sits quietly and reads with a fresh perspective. However, none of us can be Michael Burry, we can only be the best we can be. If I told you what woman to marry, you would be insulted; investing is highly individual though certain basic principles can be followed: Know thyself, keep track of your thought process, write down your investments and thesis, reflect on what you do well and don’t do so well, know your edge and respect the other side of the trade.

We as individuals have huge advantages over Wall Street since there the goal is to generate transactions not necessarily make money from investments. Note the typical research effort in the video link below:

Wall Street Research: http://www.youtube.com/watch?v=4zakyg3thfY  A scene from Boiler Room: RECO!

Here is an article written 22 years ago about individual investors doing better than the market. http://www.scribd.com/doc/68695119/A-Leg-Up-on-the-Market

So, yes it is possible, but YOU have to be successful in YOUR own way not by Buffett’s way or my way, but by your method that suits you. Buying bargains isn’t the only way to invest, but it suits me. The goal of this blog is to help people educate themselves through case studies and readings to develop their own approach where they have the greatest edge.

Two books that tell the stories of independent investors who have had success are: The Warren Buffetts Next Door by Mattew Schifrin and Free Capital: How 12 Private Investors Made Millions in the Stock Market by Guy Thomas. I recommend the second book.

Guy Thomas calls these independent investors free capitalists. He writes that there is no single blueprint for success. Some investors day-trade, invest based on macro concerns, some have no high school education while others have PhDs. There are no absolute entry requirements and many paths to success, so people with a variety of backgrounds have a chance of finding a way which suits them.

There were some traits that many of the investors share:

  • A precocious interest in money-making is not essential, but a strong future time perspective may be.
  • Understanding how markets work is more important to an investor than understanding technology. These investors intimately knew the strengths and weaknesses of their approach. For example, a growth investor knows that if he pays too much for growth, then capital is at risk.
  • They enjoy the process not the proceeds.
  • They have a low appetite for leverage.
  • They are not team players; they work alone.
  • They are foxes, not hedgehogs. Foxes are eclectic, viewing the world through a variety of perspectives, with no allegiance to any single approach. This contrasts with professional fund managers, who often identify with a single investment strategy, which gives the business advantage of a succinct marketing message.
  • Most of the investors hold concentrated portfolios, sometime fewer than ten shares.
  • Mainly smaller companies are chosen because they are less well researched, yet easier to understand, the directors are more accessible to the private shareholder and more likely to have meaningful shareholdings themselves; they are more likely to become takeover targets, etc.
  • They take no advice on what shares to buy. They have a psychological predilection for self-reliance and figuring things out for themselves.
  • Most realize that investing is a craft not a science.
    The craft of investing is composed of heuristics: a toolkit of approximate, experience-based rules for making sense of the world.

Options or LEAPS can be an intelligent way to invest but with caveats. Go to a recent lecture here: http://csinvesting.org/2011/10/13/lecture-8-leaps/

Regarding technical analysis, my question is what type of edge can I have if everyone sees the same chart that I do?  I do look at high volume
days after a long decline or rise since that could indicate that the marginal
investor has sold or bought, but I have no expertise in chart reading.

Let me know how your journey progresses.