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Genetics of Investing (Not Algorithms)

September 4, 2009 • Posted in Animal Spirits, Individual Investing

Two recent papers investigate the genetics of individual investing. The September 2009 paper “Nature or Nurture: What Determines Investor Behavior?” by Amir Barnea, Henrik Cronqvist and Stephan Siegel examines the degree to which genetic makeup influences individual investing behavior. The July 2009 paper “IQ and Stock Market Participation” by Mark Grinblatt, Matti Keloharju and Juhani Linnainmaa explores the relationship between intelligence and individual investing. These studies conclude that:

“Nature or Nurture: What Determines Investor Behavior?”, based on characteristics for approximately 40,000 identical and non-identical twins from the Swedish Twin Registry and associated investing data for the period 1998-2006, concludes that:

  • Genetics explain up to 45% of individual variation in stock market participation, asset allocation and portfolio risk choices (see the first chart below). Genetic influence is robust to differences in age, education and net worth.
  • Genetics explain more of the variation in individual investing behavior than does an extensive set of individual characteristics combined.
  • Family environment has an effect on the investing behavior of younger individuals, but this effect disappears as they acquire non-family experiences.

The following chart, taken from the paper, compares Pearson correlations between identical and non-identical twins with respect to stock market participation (Stock Market Participant), asset allocation (Share in Equities) and portfolio risk choices (Volatility). Correlations between twins and randomly selected age-matched individuals provide benchmarks. For all three measures, correlations are substantially higher between identical twins than between non-identical twins and between twins and randomly selected individuals.

In summary, genetic composition is an important determinant of individual investing behavior, potentially modifying/inhibiting “rational” response to data.

“IQ and Stock Market Participation”, based on IQ as measured in early adulthood, other characteristics and investing data for approximately 160,000 individuals in Finland as of the end of 2000, concludes that:

  • IQ relates positively to subsequent stock market participation. This tendency is robust to wealth, income, gender and other demographic and occupational characteristics (see chart below).
  • The effect of IQ on stock market participation is stronger than that of income.
  • IQ also relates positively to portfolio diversification, with high-IQ individuals more diversified via mutual funds and larger numbers of individual stocks.

The following chart, taken from the paper, summarizes the variation of stock market participation by both IQ and net worth. It shows that IQ relates positively to stock market participation for all levels of wealth.

In summary, people who score well on intelligence tests are more likely to invest in equities than those who do not.

The potential for corollaries seems strong, such as: “Act smart, invest in stocks.”

In overall summary, individual investors tend to have above-average intelligence but still be genetically constrained from free-wheeling use of that intelligence in making investment choices.

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