Researchers link shares, higher IQs

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 do not 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 past 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 of Newport Beach, California-based 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 stockmarket 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.

Three years after $US37 trillion of global share value was erased in a 16-month bear market, not everyone considers limiting equity ownership to be a mistake.

The Standard & Poor's 500 Index has gained 9.8 per cent annually including dividends since 1926, compared with 5.7 per cent for US Treasury bonds, according to Ibbotson Associates, a research unit of Chicago's Morningstar Inc.

Returns from the stock index have dwindled to about 0.6 per cent a year since the end of 1999, and investors had two opportunities to sell after losing more than a third of their money, in October 2002 and March 2009.

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 stockmarket, 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," Professor Keloharju 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 US families owned stocks directly or indirectly, and of those who do, 36 per cent had shares in one company.

"It's difficult to justify why someone wouldn't invest in the stockmarket, knowing what a good deal it has been," said Associate Professor 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 who scored lowest on the test and still owned stocks usually made the worst asset-allocation decisions, the authors wrote. They purchased too few companies, bought in more volatile industries, and got the worst bang for the buck as measured by the so-called Sharpe ratio, which adjusts return for risk taken. As a result, they were less likely to buy more shares in the future, the researchers said.

The study's authors said the findings had implications for social policy. Avoiding stock investments cut returns and might widen income gaps, they said. Individuals scoring lowest on the tests who still owned equities earned as much as 33 basis points 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, as opposed to opting in, Professor Keloharju said.