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Margin of Safety: How to Avoid Disaster and Find Success at Work

Benjamin Graham was an American investor and economist. Born in the U.K. in 1894, he warned no investor can ever eliminate the risk of being wrong.

They can, however, insist on never overpaying no matter how exciting the investment. He called on investors to use a margin of safety.

It’s essentially the gap between the cost of an investment and its intrinsic or natural value.

Think of a margin of safety like a seat belt.

Ideally, you’ll never need to put it to the test, but having a margin of safety in place helps prevent potential misfortunes and even disasters. It also allows for imprecision and mitigates bad luck.

How Warren Buffet Earned Millions With a Margin of Safety

Benjamin Graham passed away in 1976, but Warren Buffet cites him as a key influence. In a remembrance for Graham, Buffet wrote,

“[Graham’s] counsel of soundness brought unfailing rewards to his followers — even to those with natural abilities inferior to more gifted practitioners who stumbled while following counsels of brilliance or fashion.”

Investors like Buffet worry about risk. They don’t want to lose all of their money on a single or risky investment. When evaluating a company or investment, Buffet always applies a margin of safety.

For example, in the spring of 2002 Buffet read the annual report of PetroChina. He determined the Chinese oil and gas company was worth $100 billion. The company was selling for $35 billion.

Buffet calculated a margin of safety of $65 billion, so he bought PetroChina for $488 million and sold it in 2007 for a $4 billion profit.

Managing Risk in the Real World

Of course, we’re not all Warren Buffets in the making, but successful professionals still apply a margin of safety to their work.

Smart business managers knows how far they can allow sales to fall before breaking even. This potential fall represents their margin of safety.

Similarly, engineers design bridges to carry weight in excess of what’s permitted on the bridge itself. They also design tall buildings and skyscrapers that sway in wind streams and turbulence without collapsing.

The Eiffel Tower, for example, sways up to 13 centimetres in the wind to the alarm of many new visitors.

How to Apply a Margin of Safety to Your Work

You can apply this mental model to many real-life situations. The trick is to keep away from activities where you have little to gain and everything to lose.

If you’re running a small online business, keep two or three month’s worth of cash reserves in your bank account. This way, if you face an unplanned expense or revenues fall, you’ll still be able to pay your bills.

If you invest all of your cash flow in Facebook ads, how will you pay for web hosting or your email service provider if those expensive advertising leads don’t convert?

If you’re a busy corporate executive, commit to your boss and team that you’ll deliver a key project by a certain date.

Now you’ve little to gain by working on this project right up until the delivery date. Instead, push yourself to finish it early. This way, you have a margin of safety if something unforeseen happens.

Master Your Inner Game

It doesn’t matter if you’re an investor, founder or executive; you will always face factors outside of your control.

The market could rise or fall, your editor could cut his or her budget for freelancers, or it could rain heavily come race day.

Take heart from Benjamin Graham.

He wrote that “investing isn’t about beating others at their game. It’s about controlling yourself at your own game.”

Whether you’re an investor, athlete or artist, you can still control your inner game.

Develop more than one source of income for your business.

Calculate what’s at risk and the cost before investing time, energy or money in a project. Always pay less than you think something is worth.

Be realistic about your expectations for the future rather than indulging in idle fantasies.