Success & ability

What's the link between intelligence and success? This is the question posed by Luis in a comment on yesterday's my post. He says that whilst success is no proof of ability, it could be evidence of it: "it might be reasonable to observe success and think the person is probably smart."

Luckily, we've got some nice evidence here from Mark Grinblatt and colleagues in the form of a study of the link between IQ and stock market performance for investors in Finland.

They found that the one-ninth of investors with the highest IQ made average annualized returns of between 2.2 and 4.9 percentage points more than the four-ninths of investors with the lowest IQs. All this difference came from better buys rather than better sells, and the superior performance of those buys was dissipated within a month.

For me, this suggests that the returns to intelligence are not high in the stock market; the gap between the highest one-ninth and lowest four-ninths is quite large but 2-5 percentage points of annualized returns are modest.

One reason why IQ offers such paltry returns is that intelligence (and ability generally) can lead to over-confidence, which is fatal for investors; there's evidence that this is true for intelligent investors' choices of mutual funds. Also, if a task is impossible, no amount of ability will help us do it. Just as human intelligence has not (yet?) given us cold fusion, so it cannot give us insight into the future, because knowledge of the future is (mostly and for now?) impossible to obtain. If markets are wholly efficient, IQ is wholly useless.

Of course, IQ and ability are different things.But it's not at all obvious that using a wider measure of ability would greatly strengthen the link between stock market success and ability. Although there's evidence that extraversion and femininity can make better investors, the links between these and returns are also modest.

My point here is not one about the stock market. It's about the link between ability and success generally. If this is so hard to pin down in a competitive market such as equity investing, might it also be weak in other areas of economic life? I suspect the tendency to infer ability from success owes more to the outcome bias and post hoc ergo propter hoc fallacy than it does to hard evidence. If so, the tendency of the media and politicians to defer to the wealthy is mistaken.

Comments

[Anonymous]

On the rare occasions I have been obliged to watch TV's The Only Way Is Essex (TOWIE) I saw thick people. Yet the participants of this docu-soap all enjoyed a s standard of living far above their intelligence would determine under the hypothesis that rewards go to the most able.

The programme also exposes the lie that education is the key to escaping poverty or that a failing education system is a significant cause of Britain's economic problems. The educational attainments of most of the participants in this programme are very low and yet somehow they enjoy a comfortable standard of living, certainly higher than most of their northern British peers.

The determinants of success are manifold and will include class, financial inheritance, motivation, personality, health, opportunities and, yes, intelligence may play a part but it should not be over estimated.

[Luis Enrique]

"If this is so hard to pin down in a competitive market such as equity investing, might it also be weak in other areas of economic life?"

hmm, isn't a stock market the sort of place where you'd least expect ability to have large returns because if so able people would enter and erase those returns?

It should be obvious that luck plays a major role in success, and that "ability" should be interpreted very broadly: being the sort of character that reality TV producers like counts here.

Look at it this way - if you were to devise an empirical model of "success" would "ability" have a large a statistically significant coefficient? I think yes. Obviously. This means that if you observe "success" in an individual (absent further information) you should update your belief concerning their "ability".

I think you are just bonkers if you believe that having "ability", under some sensible definition, has no / a negligible role in determining outcomes. That really is crazy talk. You think lawyers and surgeons don't possess ability, relative to the population mean? Software coders? Footballers? Actors? Authors? In what proportion of "successful" careers is being rubbish, in whatever sense is relevant, orthogonal to your chances of success?

[Sergei]

This assumes that stock market behaviour can be rationalized and therefore requires intelligence. It is a strong assumption.

[Anonymous]

@Luis

If a regression model was constructed with success as the dependent variable then ability might well be chosen as one of the predictor variables. However, I suspect the R-squared of that regression would be low. More predictor variables would need to be added to achieve a satisfactory R squared. So ability may be a necessary condition of success, granted, but it is not a sufficient condition.

I suggest most "unsuccessful" people blame their lack of ability for their poverty / unemployment / low income, etc. Of course, it is in the interests of the wealthy that poor people believe this half- truth. Propagating this belief keeps the poor and exploited in their place. I suggest this is the implication of Chris's blog piece.

[Luis Enrique]

anonymous

it's not even a necessary condition for success, it merely increases the probability of success.

my guess is that the most important explanatory variable is the socio-economic status of your parents.

[Diarmid Weir]

@Luis - 'In what proportion of "successful" careers is being rubbish, in whatever sense is relevant, orthogonal to your chances of success?'

I think the issue is more to what extent income/wealth is a marker of 'relevant' success. And (following Anonymous) to what extent that success could be improved upon if socioeconomic factors had less impact on its realisation.

[Luis Enrique]

Diarmid

I am merely arguing ability is rarely unimportant.

yes, I don't know whether Chris has in mind income or a broader, individual-specific, notion of success. Either way, I'd still be arguing ability plays a large role. To what extent are disagreements here disagreements over the meaning of "large"?

[chris]

@ Luis - I'll grant that surgeons possess more surgical ability than the general population, and lawyers more legal ability. However, we can make this inference because such people have passed many exams in their disciplines, not because they have higher earnings. In this sense, we can infer ability because of non-market mechanisms, not market ones.
My point was that competitive markets do not strongly reward ability - something which might well generalize from stock markets to entrepreneurship generally. In this sense, the wealth that arises from entrepreneuship or financial market activity is only a very weak sign of ability.
Still less can we infer that successful people have ability beyond the realms in which they succeeded; it's almost a truism that experts make fools of themselves when they step beyond their field of expertise.
But this is just what governments do when they invite rich men to advise them on welfare policy, employment law or whatever.

[Luis Enrique]

Chris,

It's quite a leap from thinking that ability matters, to thinking that Richard Branson ought to design the welfare state. I wouldn't go anywhere near ideas like that. And I don't expect meteorologists to be good at brain surgery either.

When you write: "competitive markets do not strongly award ability" I guess you are talking money rewards, and we all know lots of intellectual careers are badly paid, but what do you mean by ability? What makes you think that a salesman earning big money hasn't got salesman-ability? Etc. I'm happy to accept that stock market investing is like a lottery and that entrepreneurs need a lot of luck, but I don't see what basis you have for making this claim.

(I don't think the existence of professional exams quite erases the fact that where competitive markets exist for doctors and lawyers (say the USA) it rewards them handsomely.)

[Laban Tall]

"If this is so hard to pin down in a competitive market such as equity investing, might it also be weak in other areas of economic life?"

There's a vast amounts of data in the US Longitudinal Surveys. My understanding is that recorded IQ (Stanford-Binet or AFQT tests) is the most statistically significant factor, above social class, when looking at income levels.

That's averages, of course - some bright people are poor, some not so bright are rich.

[Anonymous]

@Laban

Do you have a link, or a reference, to those data?

[Luis Enrique]

p.s. check the relative positions of economists and corporate executives here!

http://anepigone.blogspot.co.uk/2011/01/average-iq-by-occupation-estimated-from.html

(I have no idea about the quality of that source)

[Luis Enrique]

oh God, I just read it - it appears to be reasoning backwards from income to IQ

[Luis Enrique]

here's a somewhat higher quality piece of research

http://www.iza.org/conference_files/CoNoCoSk2011/gensowski_m6556.pdf

[Tim Newman]

As PJ O'Rourke asked:

“Why do some places prosper and thrive while others just suck? It’s not a matter of brains. No part of the earth (with the possible exception of Brentwood) is dumber than Beverly Hills, and the residents are wading in gravy. In Russia, meanwhile, where chess is a spectator sport, they’re boiling stones for soup.”

[Luke]

Chris,you say: "My point was that competitive markets do not strongly reward ability - something which might well generalize from stock markets to entrepreneurship generally."

I agree up to a point. But what is the ability that you are looking at? Is it widget making, or the ability manage and/or get to the top of a widget making company? Is it law, or the ability to persuade others that you are a good lawyer and then delegate the work to minions? In each case some ability at the first is useful if not essential. But the latter is still a talent, and not just a talent for rent seeking.

[Anonymous]

@Luke

It is class and other socio-economic factors that become increasingly relevant as one climbs the management ladder, not the technical skills required to deliver the product/service. City floor traders used to tell me that only toffs were retained for management positions - the barrow boy traders were got rid of as soon as they had reached their sell by date.

In industry too the same criteria seem to apply. A public school education and a posh accent are more likely to propel you up the management ladder. It usually has little to do with technical skills or knowledge or IQ.

And in the public sector? The upper reaches of the UK civil service are chock a block full of privately schooled and usually Oxbridge educated individuals. There is a high degree of positive correlation between private education and Oxbridge so even an Oxbridge education can not be relied upon as a badge of merit.

This phenomenon, whereby managers are promoted because of their class or other non-technical criteria, reminds me of the plaque on the wall of the firm's warehouse where I once worked. It read, " Do you want to speak to the manager or to someone who knows what is going on"

Seditious but spot on!

[Yet another Chris]

I'm no statistician, just a humble engineer so my maths and statistics are good enough. I'd say there probably isn't a simple link between success (however measured), earnings and intelligence. There are bound to be a whole range of Xs contributing to Y.

Over the years, though, I have found that some high-earning (successful?) people I've known aren't necessarily intelligent in the sense of a Mensa test. They tend to have found unique, skills and knowledge - or even talent - and been totally focused on applying it and seeing the benefits. They have found a successful formula and they push it like hell!

[Keith]

This sort of debate is depressing as it has a circular tendency like a lot of political economic controversy.

Is ability the same as intelligence? Does intelligence exist or is it a unverifiable superstition like the holy ghost? How is ability related to this intelligence thing we are supposed to believe in?

Roger Federer is a very good Tennis player; some say the GOAT ( greatest of all time ). He is also very rich. He has "Tennis ability" but is that the same as being smart? Before Tennis went professional and became a part of Global marketing Federer would not have been able to become rich from Tennis, but he would still have had "Tennis ability" and been just as Smart or stupid as any one else. Ditto for Professional footballers or other athletes.

Smart and good at money making are not the same; and smart and having skills that are market valuable are not the same. I suspect many people reason that it is smart to want to be rich and if you are rich you are to be admired as successful. This however is a value judgement. What if you have no interest in being wealthy? That makes you stupid presumably.

It is well to remember that if the demand for your skills should disappear you alleged smartness will have zero monetary value. Innovation both creates new demand for skill e.g. computer support and destroys the demand for old skills such as typesetting. It is an old but common fallacy to confuse what people do do with what they should do, and another related fallacy to ignore the importance of social context in determining market value. The productivity of each person depends on the accumulated stock of capital of society as a whole and cooperation with others. Without that surrounding context each individual is liable to exaggerate their own importance. And their own smartness.

[Anonymous]

@Keith I think you make Chris's point. Success in the market-place does not axiomatically signify ability. The real -life income and wealth levels of the TOWIE participants are cases in point.

As you correctly say, the market may or not place value on different abilities (eg your Federer example). Many abilities are not currently valued by the market. In the future these abilities may become marketable commodities. Conversely, the market may also over reward some people for their work and abilities. Many markets are rigged to achieve these effects.

Thirty or forty years ago UK CEOs and other directors earned much less (in real terms) than they do today. Does this mean that today's directors have more ability than yesterday's? I doubt it.

[Laban]

Anon - I'll see if I can find a reference when I get back from hols ... NLS homepage is

http://www.bls.gov/nls/

Re Yet Another Chris, Keith etc - the plural of anecdote is not data. Most of us know bright people who are poor and not so bright who are wealthy. It's what happens on a macro scale that's important/interesting.

[Luis Enrique]

all these [*] things are true, but they don't change the fact that ability has a large role in determining outcomes.

[*] market demand for abilities varies, smart and money making are not the same thing, productivity depends on accumulated stock of physical capital etc. etc.

[Keith]

Is Laban saying there is a error in my argument? I assume not. The macro scale of income is a reflection of many factors such as inherited wealth, demand, innovation etc. The assumption that a single very hard to quantify concept like "intelligence" is a decisive variable is doubtful. All this really involves is working backward from material success to infer the said property as universal cause.

[greg byshenk]

"He says that whilst success is no proof of ability, it could be evidence of it: 'it might be reasonable to observe success and think the person is probably smart.'"

One of the things to be careful about in this sort of discussion is avoiding tautology or question-begging.

That, is, for the question to be of any interest, one must be referring to 'ability' measured independently of the area of 'success'. Obviously, a successful stock trader has the 'ability' to be successful at trading, just as a successful football player has the ability to be successful at football. But this can't be what is at issue, for in such cases the 'ability' and 'success' are interdependent by definition.

The question can only be interesting when the issue is something more specific such as 'intelligence' (measured by IQ, for example) and 'business success' (measured by trading performance, for example).

My guess, for what it's worth, is that 'success' is some measure of 'intelligence', but only to a limited degree. It is difficult to be successful in business (leaving aside things like sport) if one is truly stupid (one must be able to muster at least a minimal level of instrumental reason), which means that 'success' indicates at least some minimal level of 'intelligence'. That said, I suggest that such a minimal level is not very high, and above that level, 'success' is at least as dependent upon other factors as upon 'intelligence'.

[Laban Tall]

"Is Laban saying there is a error in my argument?"

To misquote Apocalypse Now :

"Sir, I don't see any argument"

I see a lot of questions then two true statements.

"Smart and good at money making are not the same; and smart and having skills that are market valuable are not the same."

No one ever said these were identical. But statistically, smart people are likely, on average, to be better at money making.

(In a given context of course - see O'Rourke's remarks re Russia and chess. China's IQ won't have changed dramatically in the last 30 years, but their wealth has)

[Andrew]

Failed post.

"For me, this suggests that the returns to intelligence are not high in the stock market; the gap between the highest one-ninth and lowest four-ninths is quite large but 2-5 percentage points of annualized returns are modest."

Then you are not very intelligent yourself Chris. An absolute return difference of 2-5% in the market is astronomically huge. What if the lower return is -1% and the higher 4% compounded? An infinite relative difference.

Bear in mind how hard it is to make any money stock trading at all. Bear in mind that it is doubtful if any or many fund managers demonstrate any true "alpha" advantage in returns over the indices.

Bear in mind that a recent poll of market historians suggested they would be very happy to take guaranteed real returns of just 1%.

So again an entire "aren't I clever and mainstream-assumption-challenging with all my knowledge of biases and fallacies" discussion is built upon a false premise!

[Noumenon]

I agree with Andrew, I'm always seeing index funds saying "save 1% a year on expenses, end up with 35% more money."