CODEXCard 1 of 6 · Letters to Shareholders, Six
Margin of safety
Buy at a price that protects you from being wrong.
Margin of safety is the cushion between what something costs you and what you believe it is really worth. The idea comes from Benjamin Graham, Warren Buffett's teacher, and Buffett has praised it as the core of intelligent investing. If you estimate a business is worth one hundred and you pay sixty, you have a wide margin. If you pay ninety-five, you have almost none.
The logic rests on humility. Every valuation is a guess, and some guesses will be wrong. A wide margin means that even when your thinking is partly off, you can still come out fine. A thin margin means you need to be right about almost everything, which is a fragile position. Buffett's long record owes a great deal to waiting patiently for prices that left plenty of room for error.
The mistake is confusing a margin of safety with avoiding risk altogether. Returns require taking some chances. The point is to make sure that a single bad call cannot wipe you out, so you stay in the game long enough for good decisions to pay off.
The principle reaches beyond stocks. Leaving buffer time in a schedule, or extra savings when buying a house, applies the same idea to everyday life.
Example
You plan a road trip to catch a flight. The drive usually takes two hours, so you leave three and a half hours early. A lane closure adds forty minutes, but you still reach the gate with time to spare. Your estimate was wrong, but the buffer meant it did not matter.
Try it this week
For your next significant purchase or deadline, decide on a buffer of at least twenty percent in money or time before you commit.
From Letters to Shareholders, Six (Warren Buffett · 1979).
