We were less than a mile from the house when I pulled to the curb. Our minivan was packed for a three week road trip to the Utah parks. I had removed three seats to make room for all our stuff, but as I drove I sensed I had forgotten something. I lifted the back door and stared into the van. Instinctively I reached for the laptop case and started rummaging through it. The power cord was missing.
The computer was old and battery life was barely 45 minutes. It was 2001—the iPad was still eight years off and smart phones were prehistoric devices by today's standards. My laptop was the critical link in a chain that would allow me to be away from the office for three weeks while maintaining my business. Without the power cord I’d be dead in the water.
By our next vacation I had set up a simple packing list on Excel. Anytime I left home for even a brief trip, I opened it, made a few minor adjustments and nothing slipped through the cracks. While it's impossible to know what might have happened if I didn't have the list, if I consider how many times I’ve been in my car on the way to work and had to do a U-turn because I forgot something, then the benefit of the packing list is probably beyond measure.
We live in an investment world focused on—maybe obsessed with—big macro things: artificially low interest rates, the next bubble, European politics, climate change and a potential market crash. Admittedly, some of those big things are worth obsessing about. But of those that drive us to distraction, rarely if ever do they actualize anywhere close to our level of concern. It is the small stuff that we ignore, seemingly too trivial for our attention, where the power and leverage exists to change our future.
Atul Gawande's now famous book “The Checklist Manifesto” illustrates the power of a simple list: In 2001, Peter Pronovost, a critical care specialist at Johns Hopkins Hospital in Baltimore, created a checklist with just five items. These were procedures that doctors believed they were already doing, but in actuality they were missing at least one of them 30% of the time.
Pronovost convinced the hospital to give nurses authority to stop doctors if they missed any of the steps on the list. One year later line infections (a common problem in ICUs) had dropped to zero and the hospital calculated that eight people who might have died, didn't and the implementation of the checklist saved $2 million. Eight lives and $2 million saved. Cost of implementation: $0.00.
Pronovost expanded checklists into other areas: The share of patients who experienced untreated pain dropped from 41% to 3%; patients not receiving recommended care dropped from 70% to 4%, and the average length of patient stay in the ICU dropped by half. The magnitude of these changes was off the charts—unprecedented. But the medical establishment, far from embracing the changes, resisted them. Checklists ultimately became more common but, notwithstanding their success, their use in hospitals remains sporadic.
As Gerd Gigerenzer author of “Risk Savvy,” has pointed out, a new drug similarly effective in reducing infection “would be trumpeted around the globe and every ICU would have large stacks of the drug, no matter what the cost.”
At this point we might logically conclude that having a list—any list—is better than having no list. But that is not the case. Financial blogger Michael Kitces writes about financial planners who complain to him about their clients who aren't implementing their plans. Elsewhere I saw an estimate calculating the problem at nearly 30% of all plans. But Jeff London, a top financial planner on Long Island, told me that the only reason a plan wouldn't be implemented would be because it was a bad plan. Daniel Boorman, Boeing's checklist guru, comes to the same conclusion.
As related in Gawande's book, Boorman explains that there are good checklists and bad: “Bad checklists are vague and imprecise. They are too long; they are hard to use; they are impractical.” A good checklist covers only the most essential tasks—ones that if not done, could spell disaster.
What is it about the right list that can make such an enormous difference in outcomes? Consider the following fact: The most intelligent, experienced and skilled professionals in the world have blind spots that cause them to forget to do something they know they should be doing, but for one reason or another they just don't do it. It happens in airplanes and in hospitals—and it happens in investing.
Warren Buffett has a blind spot. So does his partner Charlie Munger. Seth Klarman, David Einhorn, Bill Ackman? They all have blind spots. And so do you, and so do I—and everyone we know. Monish Pabrai, a successful fund manager who was impressed with Gawande's ideas (and started to use checklists in his work) had a brilliant insight about this issue: Since some of the finest investors in the world made a regular practice of publicly discussing their mistakes, he would incorporate the lessons of those mistakes into his existing checklist.
After completing all of the initial analysis and research on a potential investment, Pabrai turns to his checklist. If he comes to a question he can't answer, it means there is a blind spot in his original thinking—and he has to go back and do more research until he can answer the question. In a 2013 interview with Steve Forbes, Pabrai highlighted the value of this process: After 18 months the checklist reduced his investment error rate to zero.
Zero errors? Because of a list? In an investment world where our attention is legitimately drawn to the almost unimaginable capabilities that the technological revolution has brought to us and where billions of dollars are gratefully spent to generate any edge in the investment game—a carefully thought out and time-tested check list, written on a piece of paper, provided the edge Pabrai needed.
A good checklist is the living embodiment of the observation “simple is not easy.” There are probably a million things a pilot can do wrong without endangering the plane. So checklist writers like Dan Boorman focus on what they call the “killer items”—steps that are critical but often overlooked. This is the kind of “systematic” thinking necessary to reduce thousands of possible choices to just a few specific steps that can make the difference between life and death.
In an efficient market, any investment tool offering a meaningful edge will be quickly exploited until it its use becomes so popular that the law of diminishing returns ultimately eliminates the edge. There is ample historical evidence supporting this conclusion. But the use of checklists, despite powerful evidence of their value in almost any enterprise, remains on the periphery of popular investment ideas.
Current conventional wisdom in the investment world is that human effort is a waste of time in a zero-sum game. What checklists did for flying, medicine and at least one investor (Pabrai) was to layer the benefit of systematic thinking onto existing processes, improving competence and the end result. And while the end result is obviously a critical benchmark, it isn't the only one.
Investors who choose strategies built on the avoidance of human judgement may very well end up with better returns than those who don't. But the cost of that potential benefit is not engaging in a process that builds your competence, helps you make good choices and shows you how to exploit the value of mistakes—and just how many basis points is that worth?
--- More by Marshall Jaffe: