Charlie Munger on Checklist Investing

http://www.valuewalk.com/charlie-munger-page/

Following on from parts three and four, in this, part five of a ten part series on Charlie Munger, I’m looking at Munger’s investment process and style of investing.

Checklists are an important tool for investors. The use of checklists to improve processes first started in aviation and medicine. They have become an important tool for doctors and pilots to help minimize mistakes. Atul Gawande’s book, Checklist Manifesto covers the subject in depth, although strictly speaking Checklist Manifesto isn’t a guide to financial checklists; it’s more of an essential primer on complexity in medicine. Indeed, doctors often overlook or omit steps in the multitude of tasks they have to perform every day, and as Atul Gawande argues, these are situations where a simple to-do list could help.

A quick example. According to the New York Times, during 2001 a simple five-point checklist put in place at Johns Hopkins Hospital virtually eradicated central line infections in intensive care. It's estimated that over the period 43 infections and eight deaths over 27 months were prevented.

Charlie Munger - Poor Charlie's Checklist

Charlie Munger is also an advocate of using checklists and the list that he has fund most valuable to investing was published within Peter Kaufman’s book, "Poor Charlie's Almanack".

Poor Charlie's Almanack is a collection of Charlie Munger's speeches and ideas, many of which focus on the development of investors’ skills, or as Charlie Munger would put it, worldly wisdom.

Charlie 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. And you’ve got to array your experience? both vicarious and direct? on this latticework of models. You may have noticed students who just try to remember and pound back what is remembered… the wisdom of the world is not to be found in one little academic department. That’s why poetry professors, by and large, are so unwise in a worldly sense. They don’t have enough models in their heads…"

 

Charlie Munger's checklist was designed to help investors deploy their 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."  -- Charlie Munger speech to the University of Southern California Law School.

 

Charlie Munger - Condensed checklist

Charlie Munger’s full checklist, as published within Poor Charlie’s Almanack, is extensive and difficult to follow. With that in mind, here is a condensed version as published on Stockopedia. Charlie’s full checklist is published below.

1.    Measure risk: All investment evaluations should begin by measuring risk, especially reputational. This is said to involve incorporating an appropriate margin of safety, avoiding permanent loss of capital and insisting on proper compensation for risk assumed.

2.    Be independent: Only in fairy tales are emperors told they're naked.  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.

3.    Prepare ahead: The only way to win is to work, work, work, and hope to have a few insights. If you want to get smart, the question you have to keep asking is “why, why, why?”

4.    Have intellectual humility: Acknowledging what you don't know is the dawning of wisdom.  Stay within a well-defined circle of competence & identify and reconcile disconfirming evidence.

5.    Analyze rigorously: Use effective checklists to minimize errors and omissions. Determine value apart from price; progress apart from activity; wealth apart from size. Think forwards and backwards – Invert, always invert

6.    Allocate assets wisely: Proper allocation of capital is an investor's No. 1 job. You should remember that good ideas are rare – when the odds are greatly in your favor, bet heavily. At the same time, don’t “fall in love” with an investment.

7.    Have patience: Resist the natural human bias to act. “Compound interest is the eighth wonder of the world” (Einstein); never interrupt it unnecessarily and avoid unnecessary transactional taxes and frictional costs.

8.    Be decisive: When proper circumstances present themselves, act with decisiveness and conviction. Be fearful when others are greedy and greedy when others are fearful. Opportunity doesn’t come often, so seize it when it comes.

9.    Be ready for change: Accept unremovable complexity. Continually challenge and willingly amend your “best-loved ideas” and recognize reality even when you don’t like it – especially when you don’t like it

10. Stay focused: Keep it 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. Face your big troubles; don’t sweep them under the rug.

Charlie Munger's full checklist

1.             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

2. Independence -- “Only in fairy tales are emperors told they are naked”

3. Preparation -- “The only way to win is to work, work, work, work, and hope to have a few insights”

4. Intellectual humility -- Acknowledging what you don’t 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 –

5. Analytic rigor -- Use of the scientific method and effective checklists minimizes errors and omissions

 

6. Allocation Proper allocation of capital is an investor’s number one 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

·       Don’t “fall in love” with an investment – be situation-dependent and opportunity-driven –

7. Patience — Resist the natural human bias to act

8. Decisiveness — When proper circumstances present themselves, act with decisiveness and conviction

·       Be fearful when others are greedy, and greedy when others are fearful

·       Opportunity doesn’t come often, so seize it when it comes

·       Opportunity meeting the prepared mind; that’s the game –

9. 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 don’t like it – especially when you don’t like it

10. 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