What’s The Margin Of Safety?

In investing, we talk a lot about margin of safety. It usually represents what is left over after we adjust for bad luck. Anywhere we make choices – in business or in life – thinking about “what will I be left with if this doesn’t work out,” in advance is a helpful thought experiment.

In hindsight, we can solve for luck by subtracting. As Nick Heil says, “You never really know how lucky you are until your luck runs out.” One definition of margin of safety is just realizing you were able to fight another day.

Another form of margin of safety is forward-looking. It’s trying to say, “How will we survive if things go against us” in advance. Now we’re projecting what happens if bad luck cuts into the skill involved in our plans. Again, we’re subtracting bad luck from a range of outcomes to make sure we survive.

Here are a few common places we might have a margin of safety conversation:

A client wants to know what will happen with the results of a project.

A student wants to know what will happen by applying to a college.

A friend wants to know what life will be like after they recover from an injury.

Solving for a margin of safety forces us to figure out where we’re still comfortable, and only then consider what risks to take. The less comfortable we are with a decision or potential outcome, the more margin of safety we should demand.

Back to the examples: The client might want to narrow down the range of results forgoing upside for less downside. The student might change where they apply based on costs and distance if they get accepted. The friend might assess the quality of their friendships. All still have to decide and act. Margin of safety can’t be an excuse for paralysis (which is another way to say it all too easily can be if we let it).

Like good and bad luck, margin of safety is everywhere. If we get in the habit of solving for it, we’ll have an incredibly useful tool in our decision-making toolbox.

*this may deserve its own category – more “margin of safety posts” here.