Margin of Safety
A margin of safety is a way of dealing with the reality that if things can go wrong, they will go wrong.
Webster's dictionary defines margin as the spare amount or measure of degree allowed or given for contingencies or special situations. By adding safety to this definition we arrive at a definition for Margin of Safety as the spare amount allowed or given for contingencies or special situations to keep us safe from harm or risk. To make it even simpler, it is the extra gap given to keep one safe from a bad or unfortunate outcome.
Margin of safety is used widely in many areas of life such as cost accounting, engineering, investing and time management to name just a few.
If you are traveling to an important meeting and you know it will take 30 minutes to get there then you don't leave only 30 minutes prior to the meeting. That would mean you're leaving yourself zero margin of safety. If you leave 60 minutes prior to the meeting then your margin of safety would be 30 minutes. You want to allow yourself enough time for things to go wrong because something almost always does. In this case, there could be traffic, a detour or an empty gas tank.
Investors use this mental model as well. When they are analyzing an investment to decide if they want to invest or not, they try to determine what the value is and after they figure out a value they compare the value to the price at which the investment is selling for in the market. If the investment is an apartment building that is selling for $1,000,000 and the investor believes it is worth only $750,00 then there is no margin of safety but if the investor values that apartment complex at $2,000,000 instead then the margin of safety would be $1,000,000 or more commonly referred in investing as a percent, the margin of safety would be 50%.
Margin of safety is also used in engineering as well. Many systems or structures such as buildings and bridges are intentionally built to handle a larger load than needed to allow for emergencies, unexpected loads and misuse. When I see capacity signs in elevators of apartment buildings they are usually between 2,000 to 2,500 lbs but can only carry about 5-6 people at a time. That means that if 6 people were on the elevator that had a capacity of 2,000 lbs then each person would need to weight 333 lbs for it to be at capacity. Since the average weight is between 160 lbs and 200 lbs this leaves a sizable margin of safety to allow for the possibility of the elevator getting stuck.