jmorace

The Nature of Risk

Great piece Geoff. I think you make a tremendous amount of sense here with this approach. But, I'm not sure how realistic your underlying assumption is--that an individual buy and hold a stock with a time horizon of infinity. This begs the question of why the particular selection was made for that stock in the first place.

To pick an individual equity implies a process of selection -- so even if everyone's selection process is different, some reasoning has occurred involving fundamental, technical, random or combination of reasoning schemes. But hand in hand with that selection has to be a system of rules as to how to mange these individual selections.

I see it breaking down into two areas: First, a change in the investment reasoning and second a robust system of cash management. So, if an individual equity is selected for a fundamental (or technical or combination of) reason(s), and one of those reason changes, the equity should be sold. (Note this is completely different than liquidating an asset class.)

In terms of cash management, it’s interesting to note that if a stock declines 50% it takes a 100% gain on it to get you back to zero, which is pretty hard (if not impossible) to do. So the stock should be sold well before it gets this damaged. If s/he has a coherent system of selling (and buying) rules in place, the individual equity holder will not have to confront this ugly situation. Which also precludes having a total loss (for the former owner, since they've already sold), even if the stock goes bankrupt.

That said, I do think running the stocks through the qpp program can be a useful screen to use in addition to other selection rules.

best,

JMorace