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Are You Too Smart to Be Rich?

The headline may sound ludicrous, but I'm serious.

We've learned all our lives that "smart" equals "rich." Think back to the person in your high school designated "Most Likely to Succeed." If the word "valedictorian" didn't come to mind, I'd be surprised.

But there is a mountain of evidence suggesting that being extra smart won't make you extra rich.

How the big boys fared ...
Repeatedly, at the highest levels of finance, we've seen that smarts don't necessarily equal riches.

The collapse of all-star hedge fund Long Term Capital Management gave us one object lesson. Despite boasting two winners of the Nobel Prize in Economics, the fund blew up in the late 1990s, requiring a massive bailout by just about every Wall Street heavy hitter, including Goldman Sachs and JPMorgan Chase.

We saw another object lesson just a few years later in the collapse of Enron -- the supposed "smartest guys in the room."

And more recently still, we saw one unfold as the -- as my Foolish colleague Bill Mann would say -- "Harvard-stupid" moves of Wall Street threatened our entire financial system.

It ain't just the big boys ...
But just because you and I aren't running hedge funds doesn't mean the same principle doesn't apply to us.

Economist Jay Zagorsky ran a study to determine whether brains translate into riches. His conclusion? "Intelligence is not a factor for explaining wealth. Those with low intelligence should not believe they are handicapped, and those with high intelligence should not believe they have an advantage."

In his book Outliers, Malcolm Gladwell explored example after example of how the successful became so. He concluded that "once someone has reached an IQ of somewhere around 120, having additional IQ points doesn't seem to translate into any measurable real-world advantage."

Berkshire Hathaway billionaire Warren Buffett seems to agree: "If you are in the investment business and have an IQ of 150, sell 30 points to someone else."

Is stupid the new smart?
You may notice a disconnect here. Those people I quoted above are both extremely smart and pretty rich -- including the most successful investor of our time. Yet they all seem to be saying that super-high IQs don't help you become rich.

Where's the gap? One word: arrogance.

It wasn't excess brains alone that sunk Long Term Capital Management, Enron, and the other Wall Streeters. It was excess arrogance about those excess brains -- believing that because they were smart, they could do no wrong and anyone who questioned them just didn't get it.

How to avoid disaster
For you and me, there's a clear lesson from all this: Invest humbly.

Specifically, it's a reminder to know what you know and don't know, which means abiding by Buffett's concept of the circle of competence. In other words, you should only make individual stock picks in areas where you have a competitive advantage.

A few examples:

  • In the technology space, can you predict which incumbents (e.g. IBM (NYSE: IBM  ) , Intel (Nasdaq: INTC  ) , and Akamai (Nasdaq: AKAM  ) ) can innovate and fortify their moats? Can you pick the one or two long-term winners from the hundreds of new start-ups buzzed about on TechCrunch?
  • In banking, can you wade through the incomprehensible-to-most-pros financial statements of a Bank of America (NYSE: BAC  ) or a Wells Fargo (NYSE: WFC  ) to properly assess risk?
  • In energy, do you have a good grasp of the political and supply constraints on Big Oil providers like Royal Dutch Shell (NYSE: RDS-A  ) , the definitions of terms like crack spread and grid parity, and some feel for the ultimate feasibility of the technology behind alternative plays like Suntech Power Holdings (NYSE: STP  ) .

Once you identify your circle of competence, remember that the folks at Long Term Capital Management, Enron, and Wall Street thought they had things figured out, too. Stay humble, my friends.

My colleagues at the Motley Fool Inside Value newsletter strive to follow Buffett's circle of competence advice -- and part of their circle of competence is finding companies that are undervalued. If you'd like to see -- completely free of charge -- two stocks they like right now, click here for a free report.

Already a member of Inside Value? Log in at the top of this page.

This article was originally published Sept. 28, 2009. It has been updated.

Anand Chokkavelu owns shares of Berkshire Hathaway. Akamai Technologies and Suntech Power Holdings are Motley Fool Rule Breakers recommendations. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation. Berkshire Hathaway and Intel are Motley Fool Inside Value recommendations. Motley Fool Options recommended buying calls on Intel. The Fool owns shares of Berkshire Hathaway. The Fool has a disclosure policy.

Read/Post Comments (2) | Recommend This Article (13)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 06, 2009, at 12:14 PM, MellowGuy1 wrote:

    Investing is a matter of luck in addition to knowledge and intelligence.

    IBM has diluted its stock value through excessive buy backs.

    Banks have a bad business model borrowing money at low rates and lending it out at slightly higher rates.

    Although I follow energy and alternative energy stocks, I can't pick a big winner so I diversify.

  • Report this Comment On December 06, 2009, at 10:41 PM, shovelheadbob wrote:

    Being humble, Believing that Jesus Christ died for our sin's and allowing myself to be of service to others will bring more wealth than we may realize and need, yet as long as we know that we are serving we have more than we need...Bobby

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