Checklists are critical tools for investors. By using a checklist, you can drastically improve your investment performance by refining your investment process and coming up with a repeatable strategy. Being able to reinvest capital at a continually high rate is the key to long-term wealth creation. Without a repeatable strategy, which is built by using a checklist, you are putting yourself at a disadvantage.
Atul Gawande’s book, “Checklist Manifesto,” covers the subject in depth, although strictly speaking it is not a guide to financial checklists; it is more of an essential primer on complexity in medicine. Gawande argues that these are situations where a simple to-do list could help.
It should come as no surprise that Warren Buffett (Trades, Portfolio)’s right-hand man and billionaire investor Charlie Munger (Trades, Portfolio) is an advocate of using this simple tool to help improve the investment process. Munger likely has many checklists he currently uses and has used many more over his career, but the list he has found most valuable to investing was published in Peter Kaufman’s book, “Poor Charlie’s Almanack.”
Munger’s philosophy is that to become successful at stock picking, and life in general, you need to have a broad view of the world.
“What is elementary, worldly wisdom? Well, the first rule is that you can’t really know anything if you just remember isolated facts and try and bang ’em back. If the facts don’t hang together on a latticework of theory, you don’t have them in a usable form. You’ve got to have models in your head.”
Which is why Munger has devised a checklist to help him effectively convey his worldly wisdom:
“Checklist routines avoid a lot of errors. You should have all this elementary [worldly] wisdom and then you should go through a mental checklist in order to use it. There is no other procedure in the world that will work as well.”
So here is Munger’s checklist for applying his worldly wisdom to all investment scenarios in full:
Risk – All investment evaluations should begin by measuring risk, especially reputational.
- Incorporate an appropriate margin of safety.
- Avoid dealing with people of questionable character.
- Insist upon proper compensation for risk assumed.
- Always beware of inflation and interest rate exposures.
- Avoid big mistakes; shun permanent capital loss.
Independence – “Only in fairy tales are emperors told they are naked.”
- Objectivity and rationality require independence of thought.
- Remember that just because other people agree or disagree with you doesn’t make you right or wrong – the only thing that matters is the correctness of your analysis and judgment.
- Mimicking the herd invites regression to the mean (merely average performance).
Preparation – “The only way to win is to work, work, work, work and hope to have a few insights.”
- Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day.
- More important than the will to win is the will to prepare.
- Develop fluency in mental models from the major academic disciplines.
- If you want to get smart, the question you have to keep asking is “why, why, why?”
Intellectual humility – Acknowledging what you do not know is the dawning of wisdom.
- Stay within a well-defined circle of competence.
- Identify and reconcile disconfirming evidence.
- Resist the craving for false precision, false certainties, etc.
- Above all, never fool yourself, and remember that you are the easiest person to fool.
Analytic rigor – Use of the scientific method and effective checklists minimize errors and omissions.
- Determine value apart from price; progress apart from activity; wealth apart from size.
- It is better to remember the obvious than to grasp the esoteric.
- Be a business analyst, not a market, macroeconomic or security analyst.
- Consider totality of risk and effect; look always at potential second order and higher level impacts.
- Think forwards and backwards – invert, always invert.
Allocation – Proper allocation of capital is an investor’s No. 1 job.
- Remember that highest and best use is always measured by the next best use (opportunity cost).
- Good ideas are rare – when the odds are greatly in your favor, bet (allocate) heavily.
- Do not “fall in love” with an investment – be situation dependent and opportunity driven.
Patience – Resist the natural human bias to act.
- “Compound interest is the eighth wonder of the world” (Einstein); never interrupt it unnecessarily.
- Avoid unnecessary transactional taxes and frictional costs; never take action for its own sake.
- Be alert for the arrival of luck.
- Enjoy the process along with the proceeds because the process is where you live.
Decisiveness – When proper circumstances present themselves, act with decisiveness and conviction.
- Be fearful when others are greedy, and greedy when others are fearful.
- Opportunity does not come often so seize it when it comes.
- Opportunity meeting the prepared mind; that is the game.
Change – Live with change and accept unremovable complexity.
- Recognize and adapt to the true nature of the world around you; don’t expect it to adapt to you.
- Continually challenge and willingly amend your “best-loved ideas.”
- Recognize reality even when you do not like it – especially when you do not like it.
Focus – Keep things simple and remember what you set out to do.
- Remember that reputation and integrity are your most valuable assets – and can be lost in a heartbeat.
- Guard against the effects of hubris (arrogance) and boredom.
- Don’t overlook the obvious by drowning in minutiae (the small details).
- Be careful to exclude unneeded information or slop: “A small leak can sink a great ship.”
- Face your big troubles; don’t sweep them under the rug.
Start a free seven-day trial of Premium Membership to GuruFocus.
About the author:
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. Prior to his investing and writing career, Rupert was as a proprietary currency trader. Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.