An edited excerpt from The Great Mental Models v3: Systems and Mathematics
When we interact with complex systems, we need to expect the unexpected. Systems do not always function as anticipated. They are subject to variable conditions and can respond to inputs in nonlinear ways.
A margin of safety is necessary to ensure systems can handle stressors and unpredictable circumstances. This means there is a meaningful gap between what a system is capable of handling and what it is required to handle.
Think of the margin of safety like a buffer zone or extra space on a busy highway; it’s the wiggle room you keep between you and the car in front, so you have time to react if something unexpected happens. It’s the extra bit you don’t use unless you really need it, ensuring you stay safe even when things change quickly. A margin of safety is a buffer between safety and danger, order and chaos, success and failure. It ensures a system does not swing from one to the other too easily, causing damage.
Solve for Extremes
Engineers know to design for extremes, not averages. In engineering, it’s necessary to consider the most something might need to handle—then add on an extra buffer. If five thousand cars are going to drive across a bridge on an average day, it would be unwise to construct it to be capable of handling precisely that number. What if there were an unusual number of buses or trucks on a particular day? What if there were strong winds? What if there were a big sports match in the area, and twice as many people want to cross the bridge? What if the population of the area is much higher in a decade? Whoever designs the bridge needs to add on a big margin of safety so it stays strong even when many more than five thousand cars cross it in a day. A large margin of safety doesn’t eliminate the possibility of failure, but it reduces it.
For investors, a margin of safety is the gap between an investment’s intrinsic value and its price. The higher the margin of safety, the safer the investment and the greater the potential profit. Because intrinsic value is subjective, it’s best this buffer be as large as possible to account for uncertainty.
Margin of safety is the wisdom of having an emergency fund, health insurance, and friends you can call on if needed. You need it the most when you don’t have it. It’s wise to build in margins of safety in all areas of life, and the more you cultivate them, the safer and more prepared you’ll feel for anything life throws your way.
When calculating the ideal margin of safety, we always need to consider how high the stakes are. The greater the cost of failure, the bigger the buffer should be.
To create a margin of safety, complex systems can utilize backups—in the form of spare components, capacities, or subsystems—to function when things go wrong. Backups make the system resilient. If an error occurs or something gets broken, the system can keep functioning. One way to think of backups is as an alternate path, like how you might have multiple routes to your office in mind so you can still get there if there’s a car accident blocking one road. A system can’t keep working indefinitely without anything breaking down. One without backups is unlikely to function for long.
As with margins of safety, the higher the stakes, the greater the need for backups. If a part in your pen breaks, it’s not a big deal. If a critical part in an airplane breaks, it’s a different story. If you’re going to the local shops, taking your phone in case you need to communicate with anyone is sufficient. If you’re going hiking in the wilderness alone, you might want more than one communication method. You’re safer in an airplane than in a car, in part because it has so much backup; after all, the cost of failure is higher.
The Silent Killer: Overconfidence
We have to be careful with margins of safety, as they can make us overconfident. If we get too reckless, we cancel out the benefits. When humans are involved in a system, too much margin of safety or backup can lead to risk compensation. For instance, we all know we should wear a seat belt in a car, but do they make us safer? Some research suggests they might not reduce car accident fatalities because people drive with less care, feeling there is a margin of safety between them and injury. This puts pedestrians and passengers at a higher risk even if drivers are safer. Still, seat belts save lives, and most of us would feel at least slightly uncomfortable riding in a car with a driver or front-seat passenger not wearing one.
The risk of a system failure is not fixed. Failure rates can remain consistent when humans are involved because margins of safety sometimes create perverse incentives. If we change our behavior in response to the knowledge that we have a margin of safety in place, we may end up reducing or negating its benefits. Setting your watch fifteen minutes ahead could help you be on time more often. If you follow the time it displays, you’ll have a buffer in case of delays. But if you remember the time is wrong and amend it in your head, it won’t make any difference to your punctuality.
Conversely, margins of safety and backups can also make us too cautious. Not all situations we face are like building a bridge, in which it either stands or doesn’t, and collapsing results in death. There is a difference between what’s uncomfortable and what ruins you. Most systems can be down for an hour. Our bodies can go without food or water for days. Most businesses can do without revenue for a little while. Too much margin of safety could be a waste of resources and can sow the seeds of becoming uncompetitive. If you know it’s impossible to fail, you get complacent. But too little margin of safety can lead to destruction. You won’t be able to weather inevitable shocks.
What If I’m Wrong?
Margin of safety is a secret weapon. It’s the buffer, the extra capacity, the redundancy that you build into a system to handle unexpected stress. It’s the difference between a bridge that can just barely handle the expected load and one that can hold ten times that load without breaking a sweat.
You can apply margin of safety to any area of life where there is uncertainty and risk. The key is to always be asking yourself: What if I’m wrong? What if things don’t go as planned? How much extra capacity do I need to build in to handle the unexpected?
But here’s the rub: building in a margin of safety often isn’t free. It means spending more upfront, investing more resources, taking on less risk. In the short term, it can feel like you’re leaving money on the table, like you’re being too conservative. But in the long run, it’s what separates the winners from the losers. It’s what allows you to survive and thrive in an uncertain world.
Margin of safety is the unsung hero of long-term success. It’s not flashy. It’s not exciting, but it’s the foundation on which everything else is built. Master it, and you’ll be well on your way to navigating the uncertainties of life with confidence and stability.
Margin of Safety is part of The Great Mental Models series and FS Latticework of Mental Models.