Are Smarter People Richer?

A while back, I wrote about the assumption made by many personal finance gurus that rich people are good with money. This is a basic tenet of a variety Blackboard Lecturing Crop of millionaire secrets books, that those rich folks got that way because they knew tricks you don’t. Of course, I don’t think it’s anything like that simple.

A new-to-me blog called Pop Economics (which I found via Smart Spending – Thanks Karen) recently brought up a similar but more philosophical question. Are smarter people better with money?

At one level, it is a silly question. Does anybody believe the contrary hypothesis, that they are worse? More or less by definition, we consider smarter people to be a little quicker to pick up mental skills and gain wisdom. That is what smart means.

Obviously, we would not expect to find a perfect relationship between intelligence and money skills, that the rank order of everybody based on some sort of IQ test was the same as the rank ordering of everybody by financial acumen. This would be as implausible as a perfect correlation between intelligence and the ability to play chess or compose songs. All we are looking for is some kind of a positive relationship, that smarter people are, on average, better with their money. And it would be hard to imagine otherwise.

Pop Economics highlights two academic papers, the first of which, more or less, addresses this non-vexing question. It discusses the relationship between intelligence and two money behaviors, risk aversion and the need for immediate gratification.

The mechanics of the experiments in the paper are a little involved, but the bottom line is that the authors managed to tease out of subjects their preferences on two elemental aspects of investing. They found out how much a person would have to get paid to give up a 50/50 chance at 300 Euros. And they found how much they would have to be paid 12 months from now to forgo a 100 Euro payment today.

Lo and behold, subjects with higher IQ scores needed more money to give up the 50/50 shot at 300 Euros and less to give up the 100 Euro check today. From this the authors conclude that there is a relationship between cognitive ability and certain economic “preferences,” namely that smarter folks are less risk averse and more patient.

But these are not preferences. These are right answers and wrong answers. And, it turns out, the smarter folks were more likely to get the right ones.

Unless you are particularly poor, selling a 50/50 draw for 300 Euros for meaningfully less than 150 Euros is irrational and stupid. And what you should be willing to accept in a year rather than 100 Euros today is hardly a question of subjective taste. What are banks paying on 12 month CDs?

The fact that most subjects muffed these problems, average selling price for the 50/50 proposition appears to be about 100 Euros and subjects needed an average of around 127 Euros in a year to give up 100 Euros now, does not mean that these are matters of personality and behavior. It means that most people have not been taught how to deal with these problems and cannot work it out for themselves in real time.

The second paper in the Pop Economics post, by Jay Zagorsky of OSU, which sadly does not appear to be freely available on-line, addresses the obvious follow-on to the finding that smart people tend to make better money decisions. Are smart people richer?

In principle, this is a much easier question to answer. You do not have to set up experiments, you only have to survey folks, checking IQs and bank accounts. But the inevitable result, that smarter people tend to have more money, upsets Marxist professor types because it also implies that rich people are smarter. Nothing could be more ideologically objectionable than the idea that the rich are, even on average, more able than others.

Thus the headline for the press release about the paper reads You Don’t Have to be Smart to be Rich. To this I cannot keep from adding “but it helps.” You also don’t have to be beautiful to be a movie star or over seven feet tall to play in the NBA.

The paper does concede that higher IQ is correlated with higher income. But how much money you have is not, which leads its author to reassure readers of the press release that “Your IQ has really no relationship to your wealth.”

Since I am unwilling to reduce my wealth by the $31.50 that the publisher of the paper wants for a PDF, I am considerably hampered in my criticism of it. I don’t know what Zagorsky used to measure wealth, nor do I know the details of the not “statistically distinguishable” relationship between it and IQ.

But I do know this: the survey subjects were all between the ages of 40 and 47. For many of the high paying professions where you might expect to find the high IQ types, lawyering, doctoring, banking, and the like, the early 40s are just the beginning of the big earning years. You would not expect serious saving and wealth accumulation to have set in yet, so you wouldn’t expect these people to have a particularly high net worth. Yet. Ask again when they are 70.

More to the point, as I have argued several times before (e.g. here and here) saving, that is, wealth accumulation, early is life is often irrational despite being conventional wisdom. Indeed, there is such a thing as saving too much. (And let’s not forget this clever post.)  Having a nice pile of cash as a 45-year-old may not be a sign of being good with money at all. It could be evidence of having made a bad mistake.

In other words, although there is obviously a (complicated and non-linear) relationship between wealth and intelligence, in some cases being smarter than average doesn’t mean you are probably richer than average. It might mean you are poorer. For now.

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