Recently, someone made a comment to me that for someone who spends most of his time in the stock market, I am hardly ever fully invested in the stock market.  While the comment was made in good pun, it got me thinking about what guided my investment decisions.

Getting overly exuberant or emotional about stocks has burnt many an investor time and again.  Yet, such exuberance rears its ugly head ever so often. One way to sense its looming presence is when you start hearing about stock purchase decisions being made with scant regard to the fundamentals of the stock, and relying solely on the thesis that there is always someone else to bid and buy it from you at a higher price (In academia, this is known as a‘Greater Fool Theory’)

One way to avoid getting sucked into this tornado is to develop a disciplined approach to investing followed by Charlie Munger called “Check Lists”.  Checklists came into prominence in 1935, when a B-17 bomber crashed during a demonstration flight (and throwing the very survival of Boeing Co. into question).  This was the beginning of the legendary four stage aviation check list – takeoff, flight, landing, and after landing. Once these checklists were put in place, there were zero accidents reported and it eventually resulted in the government order over 13,000 B-17 bombers.

Why are checklists so effective?

Our brains are designed to take short-cuts and arrive at answers quickly – our basic survival instinct often makes a fight or flight decision instantaneously. However when emotions rule and rationality takes a backseat, one is prone to make gargantuan errors in investing.

Using checklists is not rocket science.  One can develop a decent set of checklists based on simple measures such as having a sufficient Margin of Safety, evaluating performance metrics for the business, investing only in a business you understand, etc.. The trick is to make a checklist that you will really use.