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An Investment Checklist Example – Disciplined Investing (Why You Should Have A Checklist)

An investment checklist is handy, no matter your time horizon or investment style. The bare minimum is a mental checklist, but preferably it should be written. Like the aviation industry developed checklists to avoid disasters, investing is about error removals.

This article provides an investment checklist example and argues why you should have a checklist. You should have an investment checklist because it makes you avoid unnecessary mistakes, improve the outcome without increasing your skills, stay within your circle of competence, save time, and learn from your mistakes.

Why do you need an investment checklist?

It’s weird how a little tick on a notepad, or even just in your head, can give you assurance and better results without increasing efficiency or quality. Or the least, it may just contribute to your peace of mind. Well, checklists do have that sort of effect on an individual, especially for an investor or trader.

An investor has a thousand things to consider while looking at any investment. It might look like an easy matter of trade and gaining profits, but it does require a well sought out strategy and analysis. It’s no joke regarding checklists, especially when you hear that a business tycoon and investor like Warren Buffet has a checklist, even if it’s only in his head.

The investment checklist offers no magic but makes you disciplined. We argue your checklist should be as short as possible when you start out and gradually add items to the list as you learn. There is a good reason why both Warren Buffett and Charlie Munger keep an investment checklist.

Are you buying or selling shares too quickly without thinking? Did you buy it because your best friend did? Did you sell because of a rumor? Did you sell because you panicked and couldn’t stand the pain anymore? Even simple procedures often go wrong without checklists. We overestimate ourselves, and we take mental shortcuts.

An investment checklist can help you answer questions like this:

  • What are the things to consider before you invest?
  • Where should you invest to get good returns?
  • What should you look for in a company to invest in? (you need a stock checklist)
  • How do you know if you should invest in a company? (you need a stock analysis checklist)
  • How do you pick a good stock?

Investing is like a continuous process

The checklist aims to make investing a process. A process sounds bureaucratic and boring, but it’s a rational framework for evaluating a potential investment that leads to a wide range of advantages.

Atul Gawande has written an excellent book called The Checklist Manifesto. It was, and still is, a bestseller that we strongly recommend reading.

As a doctor, Gawande often witnessed doctors omitting steps in the multitude of tasks they perform daily. In the book, Gawande gives many examples of how a checklist has improved the results of seemingly simple tasks.

For example, a five-point checklist implemented in 2001 virtually eradicated central line infections in the intensive care unit at Johns Hopkins Hospital, preventing an estimated 43 infections and eight deaths over 27 months. When the checklist was later tested in ICU’s in Michigan, the checklist decreased infections by 66 percent within three months and probably saved more than 1,500 lives within a year and a half.

Can this recipe be transferred to the stock market?

Yes, most investors use some checklists, but most likely mental ones. We believe you can improve your results by formulating your philosophy and rules on paper. Writing is a powerful tool. What might be obvious in thinking might not be so obvious when you start writing.

Know your investment style

First, make sure you know your investment style. If you are unsure if you have one, write down the essence of your investment philosophy on paper.

It would help to find your own investment style that fits your personality. However, your investment style should evolve with time as you learn and adapt to changes. Your goal should be to become an investment agnostic and be open and humble for learning.

You are most likely wrong if you believe you have found a magic bullet. What works today is not guaranteed to work tomorrow. The market changes all the time. The only constant is change. This is the main reason why an investment checklist shouldn’t be too specific.

Warren Buffett and Charlie Munger’s investment checklists

To our knowledge, neither Buffett nor Munger have a written checklist, but we are pretty sure they have a mental one.

The famous Indian investor Monish Pabrai once paid 650 000 USD to have lunch with Warren Buffett (for charity). He found out Buffett doesn’t have a written checklist during the conversation but a mental one. Pabrai claims, according to Atul Gawande, that Buffett made a mistake in not having a written checklist. When Pabrai looked through Buffett’s investments over many decades, he noticed that Buffett omitted a few factors that made him make the same mistake several times.

Does Buffett’s partner, Charlie Munger, have a checklist? Like Buffett, he seems to use a mental rather than a written one. However, in Poor Charlie’s Almanac, written by Peter Kaufman, the authors compile a list of what they believe constitutes the investment checklist of Munger:

  • What is the risk?
  • Prepare ahead
  • Have intellectual humility
  • Analyze rigorously
  • Allocate assets wisely
  • Have patience
  • Be decisive
  • Be ready for change
  • Stay focused

These are very general rules, and we can argue it is not a checklist. Nevertheless, we suspect Munger likes it that way to give him wiggle room. He’s open to most investments as long as he can understand the risk and reward compared to the opportunity cost.

Keep your investment checklist short

We suggest you keep the list as short as possible and not too specific, at least when you start and dip your toe in the water. Atul Gawande writes that the first checklists made by pilots could be fitted on an index card:

The test pilots made their list simple, brief, and to the point – short enough to fit on an index card, with step-by-step checks for takeoff, flight, landing, and taxiing. It had the kind of stuff that all pilots know to do. They check that the brakes are released, that the instruments are set, that the door and windows are closed, that the elevator controls are unlocked – dumb stuff. You wouldn’t think it would make that much difference. But with the checklist in hand, the pilots went on to fly the Model 299 a total of 1.8 million miles without an accident.

Why have an investment checklist? Both Warren Buffett and Charlie Munger have one

The purpose of a checklist can be summarized into several subheadings. This is what we believe are the most important reasons for having an investment checklist:

Removal of errors – avoiding mistakes

….whether running to the store to buy ingredients for a cake, preparing an airplane for takeoff, or evaluating a sick person in the hospital, if you miss just one key thing, you might as well not have made the effort at all.

-Atul Gawande, The Checklist Manifesto

There is a good reason why the aviation industry is preferred for its high use of checklists for any task from flight checks to a pilot addressing extensive checklists for performing engine checks while taking off and landing. It typically has become a mandatory protocol to follow through the checklists for anyone in this sector.

The reason behind the need for such extensive use of a checklist is to avoid any scope of mistake when facing complex or repetitive tasks. Humans have a basic nature of forgetting or skipping through steps causing mistakes that may have grave consequences. As the tasks get complicated or increase in number so does the need for a checklist.

Our brains in time develop the tendency of finding shortcuts and give into hasty decisions. However, when it comes to investing and trading, a well-thought analysis is a crucial part of developing a strategy and checklists are a great tool in accomplishing this goal. Every investor should develop a checklist while analyzing a stock or company. It is part of growing as a successful investor to put off error out of haste while investing.

All investors have biases and cognitive errors that lead to mistakes:

  • Confirmation bias
  • Anchoring
  • Rigid mindset
  • Dividend bias
  • Loss aversion
  • Information bias
  • The endowment effect
  • Hindsight bias
  • Resulting
  • Group thinking
  • Fear of missing out

Unfortunately, the list is long, and the above is just a few of the mistakes we frequently do.

Why has Berkshire Hathaway been so successful? One obvious reason is that they are patient and have no problems sitting on their hands. Very few can do that. The temptation to take profits makes most investors sell good investments before it starts compounding.

Moreover, Berkshire has been good at error removals. Both gentlemen can change their mindset when they realize they are wrong. They have the mindset to overcome most of the biases that haunt most investors and don’t walk into the office with any particular investment biases. Buffett and Munger have numerous times argued the case for focusing on your behavior. A checklist helps you remove many of the mental biases.

Importantly, error removal helps you improve your outcome without increasing your skills:

Improve outcomes without an increase in skills

“When surgeons make sure to wash their hands or to talk to everyone on the team” – he’d seen the surgery checklist – “they improve their outcomes with no increase in skill. That’s what we are doing when we use the checklists.”

– Atul Gawande, The Checklist Manifesto

By removing unnecessary mistakes, you improve the outcome without increasing your skills! However, we can argue that you increase your skills if you avoid cognitive mistakes, a skill few master.

Stay within your circle of competence

Before understanding the concept, the circle of competence is a part of your checklist and an early part of that, specifically in investing. The concept is quite old and religiously followed by many investors. Warren Buffet popularised it through his Berkshire Hathaway letter to shareholders.

Warren Buffett invests within his circle of competence. Again, staying within your circle of competence makes you remove errors and mistakes. You should always aim to widen your circle of competence, but don’t get stubborn if it doesn’t work. If it doesn’t work, retreat to your circle.

The concept quickly caught wind, and the question came- what is the circle of competence and why is it important in investing.

Understanding the circle of competence

In layman’s terms, this concept advises that one should only invest in businesses that they properly understand. The concept targets a very simple question- can you do something that you know nothing about? And even if you do, the risk of making costly mistakes becomes extremely high as compared to when you actually know what you are doing.

For instance, the owner of a restaurant would hold significant knowledge about the restaurant’s economy, including the workings of its business model, how to expand the restaurant with the required capital, revenue generation process and time, etc. So since this owner has extensive knowledge of this business, he would have a better chance of succeeding if he invested in other restaurant chains or businesses like Domino’s, Pizza Hut, Taco Bell, etc., instead of heading towards IT industries that he probably knows nothing about.

Along with helping an investor avoid mistakes and make quick & efficient decisions, the circle of competence also contributes to narrowing down the selection of stock while looking into the stock market. Since thousands of stocks are listed on US exchanges and markets like the Indian stock market, it becomes completely impossible to analyze and understand all of them. It is a smart decision to go with your competence when choosing and investing in a stock.

A checklist saves you time

When he first introduced the checklist, he assumed it would slow his team down, increasing the time and work required for their own investment decisions. He was prepared to pay that price. The benefits of making fewer mistakes seemed obvious. And in fact, using the checklist did increase the up-front work time. But to his surprise, he found they were able to evaluate many more investments in far less time overall.

– Atul Gawande, The Checklist Manifesto, referring to an anonymous investor

As much as it is natural to understand checklists role play in avoiding disastrous mistakes, they also contribute to saving time. Apart from the easement and pocketing time by simply ticking on your list, checklists eliminate the time wasted while recalling or rechecking due to lack of assurance.

A checklist can narrow down the potential investment candidates by eliminating many stocks. The world is complex, and it’s easy to get astray by looking at complex investment alternatives. A checklist forces you to spend less time on complex issues and go for the low-hanging fruit you understand, which is within your circle of competence.

Especially for an investor, it gives them an edge to deciding which investment is worthy or not. A lot of investors waste time in going through heaving, reading, running numbers, analyzing tons of data, and then critically thinking over the conclusion before they come to a final decision. That is practically a tedious, sometimes boring, and time-consuming method.

Once an investor sets their remarks based on a checklist heavily adds efficiency and time effectiveness to the overall process. A practical checklist makes it easy for an investor to quickly and easily determine which company to invest in.

It is famously said that If you have a helpful checklist, you improve your outcome without any increase in skills.

Deal with the unexpected – randomness and noise

Most investors have an information bias: by reading on the internet, reports, TV, etc. But the news is unlikely to make you a better investor. Quite the contrary, you are likely to become a worse investor by consuming news. Nassim Nicholas Taleb once said that if you want to bankrupt a fool, give him lots of information.

Investing is about making it as simple as possible, and that’s when an investment checklist comes in handy. Simplicity trumps complexity.

Never underestimate the element of luck. Recognizing that the element of luck plays a vital role in outcomes make you suffer less from “resulting”:

Compound knowledge – don’t suffer from “resulting”

Take a moment to reflect on your best decision during the last year. Likewise, spend some thinking about your worst decision. Annie Duke argues that the best decision preceded a good result and the worst decision preceded a bad result.

However, that’s because we judge our decisions by “resulting”.

A good decision sometimes results in a bad outcome, and a good outcome can happen after a bad decision. We often fool ourselves by judging the quality of the decision based on the end result.

You’ll have problems learning from your decisions if you have a resulting bias. To avoid “resulting”, you need to focus on the decision process, which an investment checklist is all about.

Never forget that life is a perpetual state of learning. Experience is an effective teacher but only if you are willing to listen.

A checklist removes the complexity

Checklists may be simple to understand but deliver excellent efficiency, precision, and easement results, especially under complex situations. Good checklists are known to deliver crisp outcomes. They act as reminders of necessary steps and don’t necessarily need to detail everything. A bad checklist, however, can be longer than it needs to be, unclear, difficult to use, imprecise, and detailed.

An example of an investment checklist

When you start, the investment checklist should be easy to perform and follow and not too detailed. Why is that? Industry specifics vary. For example, the broadband business can handle higher debt levels than cyclical oil companies.

Moreover, a checklist is not a to-do list. It’s almost the opposite: it’s just as much a list of what not to. The investment checklist’s main purpose is to reduce risk/uncertainty and ensure you stay within your circle of competence.

Do you understand the business model?

Charlie Munger is famous for labeling his investment into boxes named “yes”, “no”, or “too difficult”. Most likely, the last box should be used frequently. Research shows that only a small fraction of the public companies manage to beat the Treasury bills over their lifetime. Why would you invest if you don’t fully understand the business model?

What are the future earnings?

The intrinsic value of a company is the discounted future cash flows. Your return is thus dependent on how well you can forecast the company’s earnings power. This is not easy. How likely are you to estimate the earnings 1-2 decades ahead?

For example, if you invest in an oil company, the earnings are dependent on the oil price. Good luck in predicting the oil price!

Are insiders aligned with outside investors?

To reduce the agency problem, you better ensure the management’s interests align with you as an outside investor.

The family businesses outperform because they stand to lose, just like outside investors, if they make unwise decisions. Thus, they are more likely to be conservative and prefer to err on the safe side. They are less fragile:

Is the company fragile or antifragile?

Nassim Taleb invented the word antifragile. What happens with your investment in a recession? Can debt ruin the company? Taleb distinguishes companies that can be labeled “rocks” or antifragile. Both are robust, but the latter thrives during volatility. Examples of “rocks” are tobacco and alcohol stocks. They are robust and resilient and can withstand recessions.

However, an antifragile company is stronger. It can evolve and adapt to become stronger during volatile times. Amazon is a perfect example of this. Most likely, the antifragility comes from within their corporate culture.

Be selective. Very few companies are worth investing in.

Is the valuation justified?

As Benjamin Graham advocated in his legendary book The Intelligent Investor, you want to invest with a margin of safety. You want to buy at a lower price than the intrinsic value.

Of course, the intrinsic value is difficult to ascertain and is something of an “art” to calculate.

However, if you are contemplating investing in a company that, for example, has a historical return on invested capital (ROIC) of 30%, and is trading at an earnings multiple of 30, it most likely turns out to be a good investment if you are patient and the ROIC doesn’t deteriorate.

Perhaps surprisingly, you can pay a high valuation multiple for a good business that has a high return on the invested capital:

Is it a better idea than what you already own? The opportunity cost

Charlie Munger once said his opportunity cost is Berkshire Hathaway and Costco – at the right price. It means he always compares any new investment with these two companies. It makes a lot of sense: why would you diversify into inferior investments compared to what you already have? When you have money to invest, look at investment opportunities in companies you own.

Why invest in your 15th best investment idea when you can add to your best idea? The best money managers run concentrated portfolios. Furthermore, you have one more advantage by investing in what you already own: you most likely are within your circle of competence.

Conclusion: why you should have an investment checklist

Discipline is hard, and we like to take shortcuts. Most people eat snacks even if they know it’s bad for their health. Likewise, we can’t tolerate the neighbor making money riding the latest investment fad, and you invest in fear of missing out. Very few can look for patterns of mistakes and how to improve decision-making. Mistakes are often recurring time after time.

What is the solution? The investment checklist, of course. Start with a small investment checklist and make it longer as you learn. Living is learning; as you get older and wiser, you develop your investment checklist. As Annie Duke would say, life is about thinking in bets and learning.

You should have an investment checklist because it makes you avoid unnecessary risk, improve the outcome without increasing your skills, stay within your circle of competence, save time, and learn from your mistakes. Warren Buffett and Charlie Munger have an investment checklist, and so should you!

We provided an investment checklist example, and hopefully, it can help you get started.

FAQ:

– How does an investment checklist contribute to error removal in investing?

An investment checklist helps remove errors by guiding investors to consider factors such as biases, cognitive errors, and common trading mistakes, ultimately improving decision-making.

– How can an investment checklist help me stay within my circle of competence?

The checklist prompts investors to assess their understanding of a business model, future earnings, alignment of insiders with outside investors, and whether the valuation is justified – all crucial aspects of staying within one’s circle of competence.

– How can an investment checklist contribute to improving decision-making in the long term?

An investment checklist encourages a process-oriented approach to investing, leading to a wide range of advantages over the long term. It helps in learning from mistakes, staying disciplined, and continually refining one’s investment strategy.