Portfolio outcomes: Higher IQ is not associated with enhanced investment performance

The effects of personality and IQ on portfolio outcomes. Chris Firth et al. Finance Research Letters, November 4 2022, 103464. https://doi.org/10.1016/j.frl.2022.103464

Highlights

• We investigate the effects of personality (Big Five traits) and IQ on individuals’ stock portfolio outcomes (activity, biases and performance)

• We use 1238 customers’ responses to a self-report survey and matched with their portfolio trading data.

• Traits have small but significant effects; higher IQ is not associated with enhanced investment performance.

• Other factors, such as customer age, portfolio size and portfolio risk, much better explain outcomes. Financial literacy shows little effect.

Abstract: We use responses to a self-report survey and matched administrative data to investigate the effects of personality (Big Five traits) and IQ on individuals’ stock trading portfolios. Traits have small but significant effects: openness and extraversion are associated with undesirable outcomes whereas conscientiousness is associated beneficially. Higher IQ is associated with lower trading activity but not enhanced investment performance. We postulate these factors influence outcomes in a complex manner, and exert over long timeframes. With portfolio size held constant, financial literacy has little effect. Other factors, such as customer age, portfolio size and portfolio risk, better explain outcomes.

JEL: D14 D91 G11

Keywords: individual decision-makingpersonality traitsBig Fiveinvestment biasesfinancial literacyIQ

3.1. Big Five personality traits

Internal consistency, measured by Cronbach's alpha, ranges from 0.31 to 0.72 for the five TIPI-derived traits and is consistent with (Gosling et al. 2003) (who also show strong correlations from a much longer inventory).

Coefficient sizes from the regressions for trait variables are consistently small7. Typical is the coefficient of 0.05 on conscientiousness (Big5_C) for the regression on Sharpe (investment performance). We interpret this as saying that on average a one standard deviation increase in conscientiousness improves performance by 5% of a standard deviation of the variable Sharpe. Despite the weak effects, the presence or not of statistical significance and the signs of coefficients offer useful insights. In summary: openness (Big5_O) has a negative association with login rate and positive associations with overconfidence and idiosyncratic risk; extraversion (Big5_E) has positive associations with overconfidence and negative associations with idiosyncratic risk and investment performance. We could explain this by suggesting that extraverts – being easily bored – take excessive, unrewarded risk. We might also speculate they would trade more and be more vulnerable to the disposition effect but that does not feature in our results.

Conscientiousness (Big5_C) has positive associations with overconfidence and investment performance. Roberts et al. (2011) report that conscientious people earn more money, which is comparable to our finding of a positive link between conscientious individuals and better returns. Kleine et al. (2016) report that openness tends to have a negative impact on portfolios; we too see that openness is associated with less desirable portfolio outcomes.

3.2. IQ

The IQ scores in our sample are as expected for a general population (see online appendix); we may reasonably state that the brokerage customers are not exceptionally intelligent. The regressions indicate that IQ very weakly predicts lower portfolio activity8. We observe no significant associations between IQ and biases of disposition effect and idiosyncratic risk, though there is a lessening effect for overconfidence. We report no statistically significant effect of IQ on the economically relevant measure (Sharpe). Although these coefficients are directionally consistent with results in (Grinblatt et al. 2012), their lack of statistical significance is somewhat surprising. However, there could be plausible reasons this. Firstly, we have a much smaller sample size than do Grinblatt et al. (2012), and, secondly, the IQ measure we use – from Raven and Court (1998) – is arguably independent of formal education (Almlund et al. 2011) which avoids potentially confounding IQ with numeracy9. Numeracy is known to be an important predictor of success in everyday risk and financial decisions (Smith et al. 2010; Cokely et al. 2012; Peters 2012).

3.3. Financial literacy

Financial literacy (FinLit) shows no statistically significant effects across six of the regressions, the main exception being the (undesirable) positive coefficient on overconfidence (OverCon). There is also weak evidence of a reduction in the disposition effect (Disp). Fernandes et al. (2014) find that effects of financial literacy diminish when variables for psychological traits are added. Instead, we observe an analogous role for portfolio size (Size). In regressions with Size excluded, financial literacy shows significant effects (see online appendix). These coefficients moderate sharply with Size included (expressed alternatively: with portfolio size held constant, financial literacy does not affect outcomes). For example, excluding Size, a one standard deviation increase in financial literacy lowers idiosyncratic risk by 8% of a standard deviation of the variable Idio. With Size, the effect of literacy is not distinguishable from zero and the coefficient for Size is 17% (see Table 4). We record a correlation of 0.21 (significant at 1%) between IQ and financial literacy (see online appendix). Muñoz-Murillo et al. (2020) likewise find that individuals with higher cognitive abilities are more financially literate.

Taken together, these results hint at a nuanced causal relationship in which those with larger portfolios are more financially literate—either because those more literate are confident enough to hold larger portfolios or because those who plan to hold larger portfolios deliberately acquire a higher level of literacy—but that variance in financial literacy over and above that due to portfolio size has no further effect.

We repeat our earlier caution that the high but uniform financial literacy of our sample customers – in itself noteworthy – could hinder inferences. Moreover, financial literacy could be endogenous, leading to biased parameter estimates. We attempt to overcome this by conducting age-instrumented estimates of the effects of financial literacy (see online appendix) based on the premise that customer age is exogenous, together with evidence from Agarwal et al. (2009) that financial mistakes decrease with age (until the onset of mental impairment). While our IV results are consistent with the overall pattern in our main analysis, we conclude that the methodological hurdles surrounding our financial literacy variable leave the question of its effects unsettled.