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Why Intelligence Alone Can’t Make You Money in Investing

The legendary investor Peter Lynch once said that “Everyone has the brainpower to make money in stocks. Not everyone has the stomach.” He was trying to point out that intelligence is the not only thing that matters in investing.

It’s something we have to note: Just because we’re smart does not mean we’d necessarily succeed. The world of finance is littered with incredibly brilliant folks who have crashed and burned in the markets.

The hedge fund Long Term Capital Management (LTCM) is perhaps the most egregious example. It was staffed full of PhDs and even had two Nobel Prize winners, Myron Scholes and Robert Merton, in its ranks. Warren Buffett, one of the best investors the world has seen over the past five decades, once said this about the firm:

“If you take the 16 of them [in LTCM], they probably have the highest average IQ of any 16 people working together in one business in the country, including Microsoft or whoever you want to name – so incredible is the amount of intellect.”

The fund opened its doors in February 1994. One dollar invested in it at that date would have become 30 cents by September 1998.

Okay. Perhaps the geniuses at LTCM were unlucky. A few of them, including Scholes, likely thought so because after LTCM’s demise in 1998, they had set up another investing firm employing a similar investing strategy of arbitraging minute price differentials between similar securities.

In 2008, the new firm, called Platinum Grove Asset Management, lost 38% of its value from the start of the year through the 15th of October. Scholes retired from his Chairman role at Platinum Grove in 2011.

John Meriwether, the founder of LTCM, was another of the infamous fund’s alumni who decided to have a second helping at the investing business. In 1999, Meriwether launched a new fund. But it sadly collapsed in 2009 after clocking what seems to be debilitating losses during the global financial crisis.

Andrew Lo, who has no links to the LTCM crew, is another really smart man (he’s a finance professor at the Massachusetts Institute of Technology) who had an abject time in the financial markets. In 2009, Lo had started his own fund in the U.S. It gained 15% in 2010, but then went on a three-year losing streak thereafter (of 2.7% in 2011, 7.7% in 2012, and 8.1% in 2013). The fund was finally shut in 2014.

It’s worth noting that 2009 was the year when many major stock markets around the world had bottomed-out after the global financial crisis started. As an example, from the start of 2009 to the end of 2013, the S&P 500 in the U.S. (a major market index there that is akin to the Straits Times Index (SGX: ^STI) in Singapore) had nearly doubled. But even with such a strong rising tide, Lo’s boat couldn’t be lifted – it sunk instead.

One of my favourite examples on the limits of brainpower in determining investing success comes from an anecdote in The Quest for Alpha: The Holy Grail of Investing, a book by Larry Swedroe, Director of Research at investment advisory firm Buckingham.

MENSA is an organisation whose members are made up of individuals with IQs in the top 2% of the population. In the 15 years ended 2001, the S&P 500 had gained over 15% per year. Guess how did the investing club of MENSA in the U.S. perform? Swedroe’s book showed that they achieved an annual return of only 2.5% per year.

Brainpower is important in many areas of life – this includes finance. But as Buffett once said, “You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.”

What investors need is, as alluded to earlier by Lynch, the right temperament. Other important ingredients would be (1) the recognition that stocks are a piece of a business, (2) patience, because time is needed for stocks to compound in value, and (3) a healthy dose of skepticism toward the use of borrowed money to invest. To the last point, LTCM had collapsed because it was simply too leveraged – at the end of 1997, LTCM had borrowed $30 to invest for every $1 in asset it had.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.