Margin of Safety

(May 5, 2007) Charlie Munger believes that the margin of safety process in investing is similar to processes that exist in engineering. For example, if you are building a bridge, as the engineer you want to make sure that it is significantly stronger than necessary to deal with the very worst case.

Warren Buffett wrote once: “When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000 pound trucks across it. And the same idea works in investing.”

Charlie #Munger believes investing should be similar. The first rule of investing is: do not make big financial mistakes. The second rule is the same as the first rule.

Behind the margin of safety principle is the simple idea that having a cushion in terms of excess value can protect you against making an error. If you buy at a discount, you have a margin of safety, which will help protect you from making mistakes. This will improve your odds of success. Everyone makes mistakes, so having insurance against those mistakes is wise. Finding an investment opportunity with the right margin of safety is uncommon, so you must be patient. The temptation to do something while you wait is too hard for most people to resist.

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