Margins of Safety: Advantages, Disadvantages, and Uses

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The margin of safety is a principle commonly applied in investing which states that an investor should only buy securities when the market price dips substantially below their estimated value. The margin of safety is the difference between the value and the market price.  

In accounting, it can refer to the difference between actual sales and the sales that need to be made to break even. Similarly, in engineering, it refers to the ability of a structure or system to withstand pressures larger than engineers expect.

The margin of safety has applications in other walks of life too.

In the rest of this piece, we’ll explore some areas of life in which maintaining a margin of safety can be very useful. First, though, we’ll detail the chief advantages and disadvantages of having one in place.

Without further ado, let’s get into it.

Advantages of a Margin of Safety

You might be wondering how a margin of safety can serve you. Let’s find out.

Makes room for mistakes – A large safety margin gives you space to make mistakes and errors without incurring too big of a cost, in lost opportunities or otherwise.

This means you will stand out from the crowd – If you have a margin of safety, you will be more likely to make smart, logical decisions and will not be unduly influenced by the actions of others.

Guards against risk -It protects you from risks to your company, risks posed by the market, and risks associated with your own faulty decision-making.

Now it’s time to look at the disadvantages of having a safety margin in place.

Disadvantages of a Margin of Safety

Here are the main drawbacks of a safety margin.

It’s highly subjective -The way everyone works out their margin of safety is highly subjective and may not suit other people.

A margin of safety does not eliminate all risk – No matter how large your buffer is, it will not eliminate risk. For example, if you leave half an hour before you are due to arrive somewhere, circumstances can still conspire against you and cause you to be late some of the time.

Less benefit for growth investors in the market – In the world of finance and the stock market, growth investors are more interested in maximising returns than maintaining a safety margin. Having too wide a margin can diminish returns.

Uses and Examples

As you may imagine, the idea of a margin is to protect yourself from unforeseen circumstances and problems that may arise. You can think of it as a sort of buffer against what you expect to happen and what could actually happen. Uncertainty creeps into every area of life, so your margin of safety is your chief defence against it.

Here are some examples of how you use it to live better, more productive lives. For the purposes of this article, we’ve limited these examples to the world of work and investment. Remember, having a margin of safety can benefit you in almost any area of life.

Time management

We’ve written on the topic of time management before, and it is one of the areas in which building a margin of safety is useful.

If you build a margin of safety into your daily schedule, it will help you become prompt and dependable.

If you’re forever running late, it might well be because you are living without a margin of safety in place. It is easy to do this, for example, if work meetings always take five minutes to conclude, build a five-minute buffer into your schedule. If you must be somewhere in ten minutes, then leave half an hour before, and not eleven minutes before.

If you need everything to go perfectly to be on time, you are not likely to be on time often. If you give yourself a comfortable margin of safety, an unforeseen event will not scupper your plans.

Business

When you run a small business, having a margin of safety is invaluable. It’s a good idea to have 3-months’ worth of funds in your account so that you can cover any unexpected expenses, or cope if you make less profit than you expected.

If you’re a project manager, commit to finishing a project with your team by a particular date. Then, work hard to finish the project early. This means that you have a buffer to work with should anything go wrong.

Use low-energy tasks which don’t require much thought or effort as recovery time if you want to keep moving forward with work rather than taking breaks. You can then use the energy you’ve saved to complete more complex, higher-value tasks. This approach is likely to produce better results and you might even see an uptick in productivity.

Now we’ll explore how creating a margin of safety is useful when engaged in creative work.

Creative work

Creatives often struggle to meet deadlines. To avoid disappointing agents, editors, and readers try to plan ahead so that you have a margin of safety to work with. Outline some ideas and have two or three draft articles ready to go if you’re a writer. This will function as your margin of safety.

You should always give yourself more of a buffer than you think you will need because creative work of any sort is often challenging and draining. You should always try to build a larger buffer than you think you’ll need so that you can deal with anything life might throw at you.

If you don’t have a plan in place, if you have a family emergency, or fall ill, what will you do when that deadline arrives? You’ll end up disappointing your readers.

Investment

One of the fields you need to use a margin of safety is in the world of investing. You should leave a huge margin because our predictions are wrong much of the time. When you have a margin of safety in place, you don’t have to worry about the accuracy of your prediction.

This will help you make sound investments that generate a profit that you can then use to improve your business or invest in technology that improves efficiency within the workplace.

Personal finances

To be productive, you must learn how to manage stress effectively.

One way you can reduce the amount of stress you experience is to manage your personal finances with a comfortable margin of safety.

For instance, even if you can save just ten percent of what you earn each month, then you can put the remaining ten percent into a contingency fund for emergencies. If you can do even better and live on just half of what you earn, you can cope with a huge amount of financial stress. The bigger the buffer, the more you can deal with.

Wrapping Up

Life is complicated and the future is uncertain. A margin of safety can be your buffer against random, unseen, and unpredictable events. Now that you know the benefits of having a margin of safety and some of the situations in which they are used, you can begin creating your own buffers.

Margins of safety help you gain confidence and deal with the stress of modern life.

Remember that if your life is organised in a way that only allows you to deal with the challenges you expect to face, it will be hard for you to manage anything unexpected.

The margin of safety will help you prepare and confront problems with confidence. Go ahead and build yourself a safety margin or buffer and see how it works for you.