Margin of Safety

The margin of safety (probably coined by the guru or his predecessors) is a concept of buying investments that are significantly cheaper than its intrinsic value. The key word here is "significant". We need to buy with a margin of safety to minimize the risk of losing any money.

Going back to my favourite analogy, let's assume that our friend bought the golden tap to re-sell it to another buyer. According to his calculations (see previous entry), which was the same as ours, the golden tap is worth $1060, and he bought it for $1000. So he could have sold the tap to another buyer who is willing to pay $1060 and he earns $60.

However as you can see, this trade does not have a margin of safety. What if the tap is actually worth $900 because our assumptions were wrong? What if gold dropped 10% the next day? If he bought the tap for $500, then the trade would have earned the praise of the guru himself, by having a good margin of safety.