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Margin of Safety
By Juan Carlos
A contingency or buffer to keep one safe from a negative or unfortunate outcome.
In engineering, it’s a concept that describes a system’s capacity to bear greater loads than anticipated.
In finance, investors use the term to purchase securities when the market price is below their intrinsic value.
In accounting, it refers to the discrepancy between actual sales and break-even sales.
Why Use It
The margin of safety is a critical part of some decisions to absorb miscalculations, errors, or just plain bad luck.
- It’s a built-in cushion that allows for financial losses without incurring significant adverse outcomes.
- It’s an added layer of safety for engineering projects where unforeseen circumstances might test a project’s infrastructure.
Its applications are myriad.
When to Use It
When unexpected problems emerge, establish a buffer between what you expect to occur and what could happen.
When you’re generating a maximum capacity for a load, the question is how much more durable the system will need to be to sustain an average load. Considering that testing bridges, buildings, and the like is impractical, analysis and modeling are required to deliver a level of confidence and accuracy in one’s assumptions.
In software, running a server near capacity might save money, but it leaves the site vulnerable to spikes in traffic. Load balancing servers and setting up auto-scaling mitigates that risk and lessens the likelihood of a catastrophic failure.
It is used in accounting to buffer break-even forecast estimates.
Keeping a margin of safety is vital in numerous fields because it deals with the consequences when things go wrong.
How to Use It
Suppose you are constructing a bridge with a maximum weight of 50 tons; you wouldn’t want a 50-ton truck to cross that bridge in case it’s a few pounds over the limit. So, if the expectation is for 50-ton trucks to cross that bridge, then an engineer would ensure the maximum weight is up to five times that.
A more common example is changing the oil in your car every five to ten thousand miles. Carmakers have tested oil changes that occur thousands of miles past the prescribed amount but know that real-world wear and tear varies. Running out of oil could damage or ruin the engine altogether, so it’s in the carmakers’ best interest to replace the oil sooner because there are too many unknowns. A failure of this nature is both dangerous and expensive.
The same is true about monthly expenses and budgeting. Saving money adds a buffer for unexpected costs if you lose your job or cannot work for other reasons. Moreover, reducing expenses enough to where you’re saving more than 50% of your income compounds and allows you to guard against acute financial stress, like a large medical bill.
And it also works for managing complex projects where multiple people are working on discrete tasks that need to be completed in sequence. If ten people each require two days to complete their task, it would take ten days to finish. When estimating, give each more time and plan for the worst-case scenario; it’s the best way to mitigate risk.
How to Misuse It
All information has some degree of error, and using it as the basis of your research comes with some level of uncertainty. When analyzing data to create a margin of safety, take into account its age and biases. Without prudence, a calculation can easily be exaggerated.
Using a margin of safety is beneficial for time management, budgeting, or a project. Find ways to build this valuable tool into different aspects of your life.
Where it Came From
Benjamin Graham and David Dodd coined the term margin of safety in their 1934 book, Security Analysis.
Unlock Clear Thinking
Fueled by a passion for storytelling and excitement for life design, I find joy in reframing narratives to illuminate paths toward fulfillment. My experience spans high-growth startups, filmmaking, and social impact, culminating in my authorship of “Mind Guide: 49 Mental Models for Effective Decision Making.” Through mentoring and coaching, I guide teams and individuals to discover purpose and cultivate a meaningful life.
I started in film, directing award-winning features such as ‘Know How’ and ‘Second Skin.’ These cinematic endeavors earned me recognition and allowed me to serve as a spokesperson for Adobe. I founded the White Roof Project, a grassroots climate activism campaign that mitigated the urban heat island effect and spurred community-led social change.
I carried my storytelling skills and passion for societal transformation as I transitioned into the startup ecosystem. Initially, I contributed to social impact apps, converting complex issues into accessible solutions. This early experience laid a foundation for my later work, where I led the development of groundbreaking products within high-growth startups. My work has underscored the potential of technology to innovate industries and amplify the quality of human life.