Episode #6 – Retirement Margin of Safety



Have you ever been repelling off a Cliffside?

A few years ago, we were in Cancun and did a zip-line and repelling tour. For those on video or on our podcast page, you can see a picture.

If you’ve gone repelling, maybe you thought the same thing that was going through my head, will this rope hold me?

I did a little research and found out that repelling ropes can withstand a falling weight of just under 2000 pounds.

So, if you are a human, chances are very good you weigh under 2000 pounds, so I think we’re good – assuming the rope isn’t all frayed and worn-out.

Let’s presume that most people who are repelling weigh less than 300 pounds. There may be a few who tip the scales a bit higher.

So, the question is, if people who repel are less than 300 pounds, why do they make ropes that can hold a falling weight of 2000 pounds?

Isn’t that overkill? Isn’t that being too safe? I mean wouldn’t 1000-pound weight limit be fine?

Way back in 1934, the mentor of Warren Buffet, Benjamin Graham, wrote about a book about analyzing and buying stock.

He explained the several steps that need to be done in order to feel comfortable in buying a stock, or a company.

One of those steps and in fact the final step is called “margin of safety.”

Essentially, what it means is if after you’ve looked a stock company, and analyzed a few things such as income, expenses, assets, and cash flow, you determine, what price you should pay for the stock should be.

It’s a value approach to investing.

Suppose you’ve done the analysis and determined a company’s price should be 20 dollars. This is what is called the sticker price.

However, you don’t EVER buy at the sticker price,

Everyone knows that if you go to a car lot, you never buy the car at the sticker price, or the price in stuck on the window.

That’s just the starting point of the negotiations.

Using Graham’s and Buffet’s philosophy, what you do is cut the sticker price by 50% and that then becomes your “margin of safety price.”

After building in your MOS, you would only buy that stock when it hits $10.

There are several reasons, everything from your numbers could be off, the management could mess things up, some kind of event could arise and cause the price of the stock to drop.

So, investors like Benjamin Graham, Warren Buffet, and Charlie Munger, will only invest when they can buy at the margin of safety price.

Maybe that’s why they’ve been so successful.

I think of the repelling rope’s ability to hold much more weight than necessary as it’s margin of safety weight.

Who knows, maybe part of the rope gets cut on a rock and half of its strength gone. Maybe another climber has to get onto my rope with me.

There are many other reasons I’m sure, but the one thing I do know is that we’re all very happy when we’re hanging off the cliff in midair, 200 feet above the ground, that the rope has a margin of safety and could actually hold 10 of me.

I think about the margin of safety concept when it comes to retirement planning.

Suppose you and an advisor calculate that you need $500,000 producing income for you and along with social security that should give you a comfortable retirement.

Now for you to accumulate $500,000, everything has to go just about perfectly.

I mean you have to keep your job, at least your current pay, you’ll have to save or invest the amount calculated without missing a beat.

And the rate of return that your advisor calculated also has to be achieved without fail.

You see, if you have a setback in work, take a decrease in pay, can’t save for a while because you had an emergency or a small disaster that you had to pay for.

And suppose you didn’t get the rate of return that was projected. Maybe we had another lost decade like 2000-2010 where the market was essentially flat.

With that in mind, maybe one thing you should do is plan your retirement with a margin of safety as well.

It works for Warren Buffet, and it works for repelling ropes, why not us?

So how do you plan for a margin of safety?

Well, you could get really aggressive and just like Buffet won’t buy a stock unless it’s price is ½ of what he thinks it’s worth you could do the same thing.

Assume you can only save half what you are intending. Assume you are only going to get half the return you expect.

Assume that you are only going to have half the income you expected to get from your investments.

Then if everything goes according to plan, you have a margin of safety and all is well.

Now that can seem rather disheartening, so maybe there is another way to look at this.

If you think $500,000 will do the job, then plan and invest and save to have 1 million.

That will give you a margin of safety as well. And if you fall short, you’re still going to be fine.

Now here’s the good news. When you plan for a margin of safety you have an even greater chance of accelerating past your goal.

Of having a worry-free retirement, and even if a few things went against you, you’ll likely be just fine.

It can never hurt to plan with a margin of safety and if all goes well, you’re going to be even better off.

When you think about your retirement, think about the rope. It’s built with a margin of safety, just in case the unforeseen were to happen and chances are, it’s going to protect your life!

Investing and planning for a retirement with a margin of safety, just in case, is a wise thing to do and can only put you in a safer position in the long run.

Well if you’d like to run a margin of safety analysis on your retirement plan – reach out, shoot me an email and we can talk.

And as always, if you have any questions, again, shoot me an email and I’ll answer them as quick as I can.

Email me at questions@wisemoneytools.com

So next time you go repelling – check those ropes out, and know that they have plenty of strength to keep you safe – because they are built with a margin of safety!

Take care!

 

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