A Guide to Investment Checklists

The first two commandments of investing: rule number one, don’t lose money. Rule number two, see rule number one. If only it were that easy. Warren Buffett likes to throw that line around when he’s grilled by journalists or others about his personal investing strategy. On the surface, it might seem like a gross oversimplification of his work, but there’s actually much to learn from “the oracle” and those two simple but not easy rules. To explore this idea further, you’ve got to think of investing as a repeatable process.

Pattern Machines

People are pattern-recognizing machines. If you stare at the clouds long enough, you’ll be able to predict the kind of clouds that will float along next. If you give a person two seemingly “equal” decks of playing cards, one is rigged for winning and the other for losing, eventually, your subject will develop an unconscious preference for the winning deck. They won’t be able to tell you why they prefer the winning deck, because in their mind, they’re, “the same”. They’ll just describe their choice as a lucky feeling.

Eventually, pattern recognizing leads to the formation of processes. A good process is easily repeatable and produces consistent results. Science is built on the foundation of process. Chefs create gourmet recipes and record them into processes. High-risk tasks like surgery, can be broken down into a process. And yes, investing can also be a process.

Once you have your process, it can provide a foundation for further experimentation and refinement. Though, sometimes a process alone isn’t enough to produce the results you want. The more complicated the procedure, the more steps, and the bigger the possibility of error. How do you correct for this? Enter the investment checklist.

On How To Use An Investment Checklist

In the above interview with Pope Brar, Managing Partner of Brar Investment Capital, Brar explains:

“The checklist will help you control your emotional risk. It will help you eliminate your ego… it’s not going to make your dinner, but it will help point out some of the pitfalls of the investment.”

At its essence, a checklist provides a way to mitigate avoidable errors, ensuring each step of the process is being followed correctly. Pilots use checklists before takeoff, not because they lack flying capabilities, but in the midst of hundreds of micro-steps, it’s probably best to introduce a second, objective opinion, AKA, Mr. Checklist.

The Four Sections Of Your Checklist

Brar continues to explain that his checklist contains four sections: sustainability, accountability, value of the investment, and risk. The sustainability section asks questions like, “Do you understand the core business? Do you understand the macro structure of the industry?” to establish a general long term outlook for the business.

The accountability section tries to uncover if management is doing the right things, e.g., Salomon Brothers, Enron, etc. The value section is to make sure you’re applying all the possible appropriate value techniques to establish a better valuation. Finally, there’s the risk section, which Brar breaks into two sections: emotional risk, and business risk.

Some History Of Checklists

Checklists were being used long before they were the hottest topic of productivity books and self-help coaches. As the Industrial Revolution transformed production from a room full of craftsmen to a factory of machines, demand for precision and risk mitigation skyrocketed.

Atul Gawande is a surgeon, best-selling author, and researcher. Of all the material popularizing the implementation of checklists, Atul’s book, The Checklist Manifesto has been profoundly influential. The central thesis is that there are two types of errors: the first, is caused by a lack of information, the second is made from inappropriate or nonuse of that information. Throughout the book, Atul explains that most people don’t make the first kind of error, rather, they’re more likely to make a mistake on the failure to to properly apply existing information.

In a hospital, a checklist can literally save lives. Whether it’s things like washing hands before surgery or making sure all surgical instruments are removed from the patient before closing incisions, risk mitigation is most helpful.

Now for investors, replace patients with portfolios, surgeons with managers, and complicated operations with securities, and you can see why checklists are of value in business.

Applications To Business

One of the most notable advocates of checklist investing is, Mohnish Pabrai, author of The Dhando Investor, and the Managing Partner of  Pabrai Funds. Mohnish also famously won the 2007 lunch auction with Warren Buffett. In his slides, from a lecture to Columbia Business School, Mohnish explains how he uses checklists as a form of risk mitigation.

Mohnish has over sixty items on his checklist. He also says he’s not finished adding things. Every time he makes a new mistake, it goes on the checklist. New opportunities never pass all the criteria, but it’s almost like an X-ray machine for the company, in which you establish a better understanding of what might be going on, underneath the surface.

What Else Should I Add To My Checklist?

By now, you might be feeling a bit overwhelmed, or that you might need to create your own 90-item list of avoidable investment mistakes. Relax. The investment checklist is a tool to help. It’s not meant to cause stress. Mr. Checklist can be your objective, emotionless guide when navigating complex decisions. The checklist isn’t going to give you new information, rather, it’s to help you make the best decision possible using all available existing information. In other words, are you applying what you already know?

More Recommended Video Interviews on Checklists:

Mariko Gordon on How To Effectively Use An Investment Checklist

Christian Olesen on Whether He Uses Checklists

Brad Hathaway on Using Investment Checklists

Additional Resources:

Preston and Stig’s Stock Selecting Checklist