One of my favourite Benjamin Graham investment quotes is, “The purpose of the margin of safety is to render the forecast unnecessary.”
There so much insight and wisdom distilled into that eloquent line. The major point about the margin of safety is that it removes the speculator’s need to predict the future, thus turning that speculator into an investor.
The speculator tries to predict the future, the investor plans for an unpredictable future. The speculator seeks comfort in certainty (forecasting), the investor embraces the discomfort of uncertainty (probability).
That for me is the key to becoming a successful long-term investor, implementing sustainable and repeatable principles. That requires an appreciation of the macro-view (big picture fundamentals).
Often as investors, we can get so wrapped up in the details of a particular stock, fund, or type of investment that we forget to ask ourselves a very basic, but critical, question: should we even be investing (playing this game) in the first place?
If you’re considering an investment opportunity, the first thing you’d want to know is what your chances of making a profit are, right? This is where many investors trip up. We often think we’re more likely to make money than we actually are, thanks to a little thing called overconfidence. It’s like believing you’ll definitely win the lottery just because you bought a ticket.
The trick is to take a step back and remember that, on average, we’re just that—average. This helps us set a realistic starting point for our expectations and ability to assess the margin of safety.
Now, if you do decide you’re going to invest, you need to figure out if you have any kind of advantage. What are the odds that you’ll achieve your desired outcome? If the odds are bad, and you know it, the only rational reason you would proceed is if you’re a gambler, or because you believe you know something that other people don’t know (a secret strategy).
But, before you get too excited, you really need to pinpoint and articulate what your edge is. What is this secret strategy for winning? Is it better information? A smarter way of analysing that information? Or maybe you’re just better at not making the same mistakes that others do.
Claiming you’ve got better info, or a smarter way of analysing that information is tough these days. Information is everywhere, and everyone’s got access to it. That’s also true for analysis tools and systems. So, if you’re banking on having an edge because you’ve got some secret info or a supercomputer, my guess would be that you’re either engaging in something unlawful (insider trading) or are simply delusional (overconfidence).
Instead, many believe (me included) that in the information age, the real advantage comes from understanding how people behave, betting on others making mistakes because of their emotions or poor decision-making. But even then, you’ve got to ask yourself: if I’m betting on others being irrational, what makes me so sure I’m not making the same mistakes? I’m only human (average) after all.
And who are you playing this game against? Who is involved in this investment opportunity and is ready to profit from your mistake? It’s not just about how good you are; it’s also about how good everyone else is.
Think of it like a poker game. Your chances of winning aren’t just about how well you play, but also about who’s sitting at the table with you. Investing is made up of market participants trying to outsmart one another. So, who are they, and what us their strategy? Are we playing the same game?
Not everyone in the investment world is playing the game with the same goals in mind. Some people are looking at the next 20 years, while others are worried about the next 20 days. Those 2 people can buy the same stock at the same time, but for completely different reasons and expectations of what success is.
This should be factored into any investment strategy. Understanding this can and should change how you trade and view your margin of safety. So, before you get lured in by a great story or tricked by your own confidence, take a moment to really think about what you’re getting into.
Understanding the game, knowing if and where you have an edge, and recognizing who you’re up against can make all the difference. It’s about making informed choices, with a clear head, to make sure that when you decide to invest, you’re doing it for the right reasons and with a solid strategy in place.
This way, we’re not just blindly following the crowd but making choices that are right for us, based on a good understanding of the landscape. It’s about learning as we go, and hopefully, making some smart moves along the way.
Graham’s margin of safety makes the best prediction that we shouldn’t see the world as black and white. You shouldn’t think the world is predictable. Instead, you should follow the grey area pursuing things where a range of potential outcomes are acceptable, so you can pivot when the inevitable unforeseen circumstance occurs.