Rules and Checklists Are An Investor's Secret Weapon

There’s a guy on Twitter who I followed and interacted with occasionally.

Like me, he was a conservative dividend investor whose portfolio was stuffed with boring blue-chip names. He owned stocks like Pepsi, Aflac, Realty Income, and Hershey.

I admired his portfolio, his thinking, and his clear long-term mindset. This combination is refreshing, especially in a world where it seems like investors are getting more and more impatient.

And then, a few weeks ago, he announced something that changed everything. He had a previously undisclosed 20%+ position in Gamestop, which he quietly acquired after the 2021 meme stonk mania.

The logic was simple. At some point, Roaring Kitty (aka Keith Gill) would be back talking about the stock, and it would soar. He’d then be free to unload his stake for a nice profit.

Lo and behold, that’s exactly what happened. He waited for Gill to show back up. Gill posted some memes, held a live-stream, and succeeded in shooting up the stock price temporarily. My Twitter peer sold into the strength and pocketed a nice profit.

Gill, for whatever reason, appears to be holding.

Even though I cheer for all investors and hope even the most degenerate ones make money, I had to unfollow.

It wasn’t because I was jealous.

It wasn’t because I was envious.

And it sure wasn’t because he made some move I disagreed with.

No, I had to unfollow because he abandoned his principles. He eschewed just about every sound investing practice in order to make some outsized YOLO bet on a security that has pretty much become a lottery ticket. He withheld resources that could’ve been invested in sound businesses and instead put them into a struggling retailer trading for 310x earnings.

It was nothing more than gambling, which should have no place in a portfolio. After all, as Ben Graham says “investment is most intelligent when it is most businesslike.”

Warren Buffett, Graham’s most famous student, agrees, saying “[those] are the nine most important words ever written about investing.”

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I don’t want to talk too negative about this specific person, because a lot of so-called “conservative” investors suffer from the same problems. They chase risky assets like the hot stock of the year (after it has gone up 800%) or crypto or other such assets that directly violate their investing plans.

Most people can’t help it. They see someone getting richer faster than they are and it triggers the worst kind of emotional response in their brain. Suddenly well-laid out plans are abandoned for get rich quick schemes and other similarly poor ideas.

And because of how the human brain works, we don’t see it like that. We justify. We’re not gambling on some crypto coin that has no value. We’re “hedging.” Risky, out of the money options that are likely to expire worthless are “asymmetric bets.” And penny stocks (or quasi-penny stocks like Gamestop) are revered for their “high growth potential.”

It’s all nonsense, of course, but the human brain is a tricky thing.

So this begs an obvious question — in a world where our minds easily justify such departures from the long-term strategy, how to we avoid getting into the problem in the first place?

In today’s post, I’m going to suggest a radical solution. We should embrace a rules-based investment approach using checklists. Let’s take a closer look at why such a strategy is so powerful.

A rules-based investment approach

About 6-7 years ago I sat down and considered what I wanted from my investments. It took a little while but I eventually figured out what I was really after.

I wanted investments that would allow me to grow my passive income at a pace a little faster than inflation. That would be my retirement fund.

At that point all I needed to do is choose solid stocks, save enough to get to my retirement goal income, and let those dividend raises do their thing.

A few years later I realized such a strategy was fine as a retirement plan, but it didn’t really help me pick stocks. So I did some more thinking and condensed what I’m looking for in an investment into a version of these bullet points:

• I want boring, old-school companies with moats, consistent revenue, and a history of success

• That generate gobs of free cash flow

• Which trade for a reasonable valuation

• That offer sustainable, ideally growing dividends

• To ultimately generate safe, growing dividend income and growth of my investment capital

These days, every single stock I buy gets ran though this list before I even start to research it. If it doesn’t check off every single box, I move on.

This list creates discipline I never had before. It helps narrow down the universe of investible stocks, which makes research a lot easier. And it helps me avoid many of what I call “zombie” dividend stocks — companies that offer reasonable yields but with no growth potential.

Taking my list further

Many investors take this a step farther and create checklists they fill out before they’ll put a nickel into a stock.

Mohnish Pabrai is one. He calls it the Dhando framework, which focuses on investments that fit into the following framework:

• That are existing businesses

• In industries with an ultra-slow rate of change

• Distressed businesses in distressed industries

• Which offer a moat

• With concentrated positions when the odds are overwhelmingly in your favour

• At a big discount to their underlying intrinsic value

• Emphasizing low-risk, high-uncertainty business

Personally, I disagree with at least two items on Pabrai’s list. But that’s okay. It’s his list, not mine.

Guy Spier is another investor that loves checklists as a guard against investor psychology. By running an investment through a checklist established during calmer times, an investor can talk themselves out of entering an irrational exuberance situation.

Pabrai and Spier embraced checklists once they realized Buffett and Munger were doing the same thing. The difference between Buffett, Munger, and mere mortals like you and I is Buffett is smart and disciplined enough he doesn’t need to write his checklist down. We do.

Every investment checklist should be unique. After all, we’re all in this game for different reasons. The secret is coming up with your own checklist that helps identify securities that help you reach your investment goals. Putting something like “only pick stocks that go up” on your investment checklist isn’t a very smart idea.

Steal my investment checklist

I realize coming up with your own investing checklist can be an intimating exercise, so I’m here to help.

So I’ll make it easy to get started. Grab my investing checklist for free!

The purpose of this exercise isn’t for you to steal my checklist. My list should look different than yours. After all, we all want different things from our investments. We have different goals. I might prefer dividend growth, while you might want to maximize your yield today.

The point is for you to think about what belongs on your own checklist. So use mine as a guide — but only that. If you value growth more than paying a reasonable price, then put more emphasis on it.

My more detailed checklist has 30 items on it. And I’m the first to admit every stock I own doesn’t check off all the boxes. So what I’ll often do is compare one company to another and run them both through the checklist. Whichever one scores the highest is the one I’ll focus research on.

And, most importantly, by systemizing part of my research process I’m ensuring I don’t let stocks slip in that are the anthesis of what I want. That’s the point here. The rest is just details.

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