Monday, December 10, 2007

An Investing Principles Checklist from Poor Charlie

From Poor Charlie's Almanack:
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An Investing Principles Checklist
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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
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Independence – “Only in fairy tales are emperors told they are naked”
  • Objectivity and rationality require independence of thought
  • 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 and judgment
  • Mimicking the herd invites regression to the mean (merely average performance)
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Preparation – “The only way to win is to work, work, work, work, and hope to have a few insights”

  • Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day
  • More important than the will to win is the will to prepare
  • Develop fluency in mental models from the major academic disciplines
  • If you want to get smart, the question you have to keep asking is “why, why, why?”

-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
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“Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things.”

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Analytic rigor – Use of the scientific method and effective checklists minimizes errors and omissions
  • Determine value apart from price; progress apart from activity; wealth apart from size
  • It is better to remember the obvious than to grasp the esoteric
  • Be a business analyst, not a market, macroeconomic, or security analyst
  • Consider totality of risk and effect; look always at potential second order and higher level impacts
  • Think forwards and backwards – Invert, always invert
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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
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Patience – Resist the natural human bias to act
  • “Compound interest is the eighth wonder of the world” (Einstein); never interrupt it unnecessarily
  • Avoid unnecessary transactional taxes and frictional costs; never take action for its own sake
  • Be alert for the arrival of luck
  • Enjoy the process along with the proceeds, because the process is where you live
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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
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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
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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 and boredom
  • Don’t overlook the obvious by drowning in minutiae
  • 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
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In the end, it comes down to Charlie’s most basic guiding principles, his fundamental philosophy of life: Preparation. Discipline. Patience. Decisiveness.