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Checklist Due Diligence

July 4, 2017

...excerpt from Mo Lidsky's latest book, Partners in Preservation‍


Proper due diligence may seem like an obvious need, but the unfortunate reality is that the critical task of due diligence rarely gets the time and attention it deserves. Yet, this step is truly what separates top-tier advisors and investors from the rest.

Many professions must follow structured, repeatable processes that define their ability to excel. Pilots, for example, are required to go through a set of detailed, predetermined steps every time they enter the cockpit. The bigger the risk, the more checklists and due diligence are required. Hospitals are ripe with them: nurses check and double-check everything from patient name to temperature, and surgeons triple-check basics, such as asking the patient to repeat his or her name and date of birth, before suiting up. These sometimes tedious tasks are the very foundation of excellence, but investment management has largely avoided this type of discipline. As a result, far too many investment managers and advisors expose their clients’ money to risks by making careless mistakes as a result of a lack of due diligence. It may not be the same as putting your life in the hands of a pilot or surgeon, but investing is just as much a complicated, high-stakes, and emotion-laden profession. Without a defined process, people can easily lose their way.

Some investment professionals may see checklists as tedious or unnecessary, but there is a brilliance to them. They allow investment research to be approached the same way as a trip to the grocery store (and who has not returned home only to realize he or she forgot to buy the milk?). Virtually every investment could be subject to the same set of basic, yet profoundly important, questions. Such checklist investing may seem overly artless and unsophisticated, but it is an integral part of successful investing. When advisors and investors use a checklist of standardized questions to approach every investment situation, they eliminate the chance of missing the big picture. They are forced to consider every single investment opportunity from every single angle, even if it seems like a waste of time on the surface.

Almost all investments worthy of consideration have a number of moving parts. To subject oneself to the risk of each part without probing the specifics would seem irresponsible in any environment. Imagine planning out your week without looking at what is already on your calendar or putting together new furniture without looking at the instructions beforehand. You could do it, but you are taking a chance that you will miss something. In investing, where the stakes are so high, checklists that clarify the various moving parts are an important part of the process.

Although checklists are used for some of the highest-trained professions with the highest stakes (e.g., doctors, engineers, pilots), investment advisors seem to take the idea as a personal slight. Using a checklist to make high-level decisions does require humility. It suggests the possibility of error, which many find bruising to the ego, and having one’s professional responsibilities distilled into a list can seem demeaning to a skilled professional. But this perspective is damaging. The truth is that many people are able to form an opinion about what is in front of them, but few can see what is not there but should be. Checklists allow you to avoid these oversights.

Inherent in checklists is a willingness and commitment to adopt investment discipline. The word discipline does not generally excite people, but discipline is what is needed to suspend our egos and infuse the process with the intellectual honesty it deserves. Part of this discipline is a willingness to be transparent, or honest, about your needs and gaps in knowledge, and a willingness to work with teams. Many advisors operate without communicating with others, preferring to be the white knight for their clients. Similarly, many investors are uncomfortable with collaboration, as they are sensitive about their wealth. However, proper due diligence for the advisor and the investor necessitates them to step outside of their comfort zone and engage with others. Checklists will often require us to pick up the phone, make inquiries, and conduct on-site visits and interviews.

These values—discipline, transparency, and teamwork— will bring benefits to the investor and his or her portfolio that are more than worth the effort.