Money psychology expert: Why the smartest people make bad decisions—compared to those with average IQ

(Photo: Twenty20 | Nattapong)

One of the most persistent fallacies is the reflexive association between intelligence and good decisions. 

Smart people make not-so-smart decisions all the time. Even Warren Buffett, the man widely known as the "Oracle of Omaha," has long said that IQ isn't the single defining factor to successful outcomes.

Research backs this up, too. Keith Stanovich, professor of human development at the University of Toronto, has studied the psychology of reasoning for more than a decade. His findings suggest that IQ tests are great for measuring mental capabilities such as logic, abstract reasoning and memory capacity. But the tests aren't as reliable when it comes to making smart decisions in real-life situations.

As a partner at a venture capital firm who has spent much of his career studying and writing about behavioral finance, I've witnessed several instances where high intelligence prevents people from making better decisions.

Below are two of the most common ones (and being aware of them may help you in making decisions in the future, no matter what your IQ score is):

1. Intelligence increases the ability to fool yourself with elaborate stories about why something happened.

Those with high IQ scores aren't always fast learners, because they often try to cram the real world into the theories they've been taught, while average folks are better at accepting the real world at face value.

Here's the thing: We tend to judge others based solely on their actions, but when judging ourselves, we have an internal dialogue that justifies our mistakes and bad decisions.

If you're a fund manager who earns terrible returns, I may be able to instantly point out what went wrong (e.g., buying during a bubble, selling during a panic, not enough diversification).

But if I'm the fund manager who earns terrible returns, I can tell myself a story justifying my decisions and explaining the outcome. I might say, "The Fed distorted the economy!" Or, "Look at my model. It's the market that's wrong!"

Two things come from this:

  1. We think of ourselves as less flawed than other people, because we rarely hear the internal justifications other people have for their mistakes, but we're keenly aware of our own.
  2. When you're blessed with intelligence, you're also cursed with the ability to use it to concoct intricate — and often false — stories about why things happened, especially stories justifying why you, Smartypants, made a mistake.

2. Intelligence pushes you toward the idea that complex problems require complex solutions.

Some of the most complex problems require the simplest solutions, because simple solutions are the ones that navigate around — rather than trying to steer through — parts of a problem that are fundamentally unknowable.

The brilliance of the popular dollar-cost averaging strategy (in which you start with a lump sum and invest in equal amounts over a given period, instead of investing it all at once), for example, isn't that it can tell you what the market will do next; it's that you don't need to know in order for it to work.

In Ken Burns' 2015 documentary "Cancer: The Emperor of All Maladies," Robert Weinberg, a brilliant cancer researcher at MIT, perfectly explains why highly intelligent people like himself aren't interested in simple solutions, even if they're effective:

"Persuading somebody to quit smoking is a psychological exercise. It has nothing to do with molecules, genes and cells. And so people like me are essentially uninterested in it, despite the fact that stopping people from smoking will have vastly more effect on cancer mortality than anything I could hope to do in my own lifetime."

Moreover, even when a problem does require a complex solution, the ability to communicate it in simple terms is indispensable to getting people to take you seriously.

It makes me wonder: How many academic geniuses have discovered something amazing, but written it in a paper that's so dense and complex that no one else can process it?

A lot, I imagine.

Morgan Housel is a partner at The Collaborative Fund, behavioral finance expert, and former columnist at The Wall Street Journal and The Motley Fool. He is also also the author of the upcoming book "The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness."

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