What Investors And Traders Can Learn From Atul Gawande’s The Checklist Manifesto

This weekend I reread The Checklist Manifesto, a book published in 2010. This is an outstanding book and I highly recommend it. Below you find some random arguments why I believe a checklist should be a part of the toolkit of any aspiring speculator or investor.

Both Charlie Munger and Warren Buffett use checklists. Buffett has a mental one, while I believe Munger has a written one. They both liked The Checklist Manifesto and Gawande was subsequently hired as CEO for the healthcare project between Amazon, Berkshire and JP Morgan.

Lesson number one: 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.

The aviation industry is famous for their checklists. The pilots perform checklists for starting the engines, takeoff, landing etc. Actually, whatever needs to be done involves a checklist. There is a reason for this: They are simply extremely effective to avoid mistakes when facing complex and/or repetitive tasks. The human mind doesn’t do well when faced with complex but repetitive tasks because we tend to forget or skip important steps, which results in mistakes, accidents, and other problems. There is ample evidence to testify to that. The more tasks and the more complex, the more valuable are checklists. Evolution has designed our brains to take shortcuts and hasty decisions. On the savanna, when you see a predator, you simply run without thinking, a typical System 1¬†decision. But Investing and trading should be about System 2 decisions, and checklists are a tremendous tool for achieving that.

I believe one of the most important skillset in investing is to avoid unforced errors. Victor Niederhoffer wrote the following in The Education of A Speculator:

There are so many ways to lose, but so few ways to win. Perhaps the best way to achieve victory is to master all the rules for disaster and then concentrate on avoiding them.

for example, I have a Swedish trader and friend who taught me a pretty smart backtesting rule: When you have found a potential strategy, test it live (without real money) for at least six months. Look at the trades and see how it performs. If it works well for six months, start trading with real money. If not, put it in the bin or test it longer. Very few strategies make it past this test and thus saving him a lot of money.

In medicine, one must avoid both false positives and false negatives. But in investing you need to avoid false positives, and a checklist comes handy.

Lesson number 2: Increase your skills

If you have a useful checklist, you actually improve your outcomes without any increase in skills.

Lesson number 3: You save time

The benefits of making fewer mistakes are obvious. Furthermore, a checklist gives you an efficiency edge, as you can dismiss a trade or investment pretty fast. It gives you an edge because most people hate checklists. Most people find it tedious and boring, and perhaps even an embarrassment. But it saves you valuable time. If you find a presumable great and undervalued business, you start reading, run the numbers and later arrive at a conclusion. This is unlikely to be as effective as a checklist. You just need a few good strategies or investments.

I believe Charlie Munger starts with a very simple filter by using three boxes: In, Out, and Too Difficult. This very simple checklist saves him a lot of time. He simply aims for the easy and understandable investment cases (or strategies).

I made a written checklist for both my short-term trading and long-term investing a long time ago. I believe you should as well.