Benjamin Graham in The Intelligent Investor talks about the stock investing experience of Sir Isaac Newton in the 1700s. Newton owned shares in the South Sea Company, the hottest stock in England. When the market was getting out of hand, the great physicist muttered that he “could calculate the motions of the heavenly bodies, but not the madness of the people.” He sold his stock at a 100% profit. But, he was not immune from the madness. Months later, swept up in the wild enthusiasm of the market, he jumped back in at a much higher price and lost thousands of pounds. For the rest of his life, he forbade anyone to speak the words “South Sea” in his presence.
A great example of how emotional intelligence (EQ) is probably even more important than a regular IQ when dealing with the stock market.
Ben Carlson, portfolio manager, author and columnist, recently wrote a post along these lines which has been reproduced below.
Before I really knew anything about human behaviour, incentives, and how the markets really work, I was always blown away by the sheer amount of intelligence I would come across in the investment world.
Most of the people I’ve interacted with throughout my career are highly educated at some of the best colleges and universities in the world. Many continued their education by getting advanced degrees or prestigious industry designations. They can speak eloquently, hit you with reams of data, can sell a ketchup popsicle to a person wearing white gloves, and have the utmost confidence in their own abilities.
After a few years of being impressed by the sophistication and above average IQ of the various portfolio managers, strategists, analysts, and marketing people I came into contact with, I finally had a realization – intelligence can only take you so far in this world. I didn’t exactly have an epiphany on the topic, but over time the shine began to wear off.
It became apparent that the smartest person in the room isn’t always right. In fact, most of the time their intelligence works against them because they’ve become so sure of themselves and their investing abilities that they’re unable to change their mind or accept the fact that the markets don’t care what your IQ is.
Some of the smartest people outside the world of finance can also be terrible investors.
Doctors, lawyers, and engineers are some of brightest, most educated people around. They have all put in years of study and advanced training and are compensated handsomely because of it. Yet my experience with many in this group (not all, of course) is that they tend to be horrible investors.
Why?
Because they assume success or wealth in one arena (their job) will easily translate into another (the markets). Smart people are often the most dangerous in terms of poor decision-making ability because they tend to be overconfident, make things too complex, and over-think things.
Annie Duke talks about this curse of intelligence in her excellent book Thinking In Bets: Making Smarter Decisions When You Don’t Have All the Facts
The smarter you are, the better you are at constructing a narrative that supports your beliefs, rationalizing and framing the data to fit your argument or point of view. After all, people in the “spin room” in a political setting are generally pretty smart for a reason.
In 2012, psychologists Richard West, Russell Meserve, and Keith Stanovich tested the blind-spot bias—an irrationality where people are better at recognizing biased reasoning in others but are blind to bias in themselves. Overall, their work supported, across a variety of cognitive biases, that, yes, we all have a blind spot about recognizing our biases. The surprise is that blind-spot bias is greater the smarter you are. The researchers tested subjects for seven cognitive biases and found that cognitive ability did not attenuate the blind spot. “Furthermore, people who were aware of their own biases were not better able to overcome them.” In fact, in six of the seven biases tested, “more cognitively sophisticated participants showed larger bias blind spots.” They have since replicated this result.
Duke pointed to another study that showed IQ is positively correlated with the number of reasons people find to support their own side of an argument. So being smarter makes it easier to fall prey to the confirmation bias.
At our EBI East Conference in NYC a few months ago Jason Zweig stated that the worst bias an investor can have is the bias they don’t know they have. And the research shows that intelligent people are more prone to the blind-spot bias. So even when you’re aware of your own biases, intelligence and willpower alone aren’t enough to overcome them.
3 takeaways
- Intelligent people need to realize that it’s okay to say “I don’t know” from time-to-time. And thinking in terms of probabilities (or “bets” as Duke puts it) can help you avoid the certainty trap in trying to pretend you always know exactly what’s going to happen.
- I’ve discovered that emotional intelligence has a much bigger impact on the success or failure of investors than where they went to school or how complex their investment strategy is.
- I’ve also realized that the people who go out of their way to make things sound complicated and use excessive jargon are overcompensating. The best investors in the world have the ability to explain complex topics and strategies in a way people can actually understand them.
It’s always a struggle to keep things simple in a complex world. That struggle may be even more difficult for the smartest among us.
The original post by Ben Carlson is titled The Curse of Intelligence