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How to Build a Financial Safety Net: The Margin of Safety Guide
The simpler your lifestyle is, the easier it is to afford. The truth is, many people don’t necessarily like to go for simple. Societal pressure and clever marketing encourage people to strive for unaffordable lifestyles. Some look up to people with expensive lifestyles as the ideal they aspire to. Unfortunately, all too often, things go wrong, and these people with costly lifestyles end up having severe financial difficulties. You must understand how to afford your lifestyle to ensure this does not happen to you.
Why Your Lifestyle Needs a Financial Buffer
The Hidden Risks of Overextending Your Spending
Most people don’t plan for the unexpected until it happens. Living without a financial buffer may seem fine when things are going well, but a single unexpected bill or a lost job can turn everything upside down.
Here’s a story from The Real Debt Guy that shows what can happen when your lifestyle isn’t built to withstand a shock…
Benjamin Graham’s Margin of Safety: A Lesson in Financial Resilience
2020 will live long in our memories. Nobody expected what happened that year, which was challenging due to the lockdown, the COVID-19 pandemic, the requirement to wear masks, and the need for social distancing.
During that year, I decided to take time to review my investments and assess their performance. It was also an excellent time to expand my knowledge.
I started listening to an audiobook titled “The Intelligent Investor” by Benjamin Graham. If you haven’t heard of him, Benjamin Graham was one of the greatest influencers in Warren Buffett’s life. Warren Buffett learned a great deal from him.
To make a long story short, Benjamin Graham founded an investment company that generated substantial profits for him. His company invested in securities, including stocks, shares, and bonds. He had a philosophy of purchasing undervalued securities so that they would be cheap enough to withstand stock market downturns caused by factors beyond his control. So, even if the stock market declined, his investments would still be fine. He referred to this as a Margin of Safety.
How Graham’s Biggest Regret Exposes Modern Financial Traps
Benjamin Graham’s business allowed him to enjoy a lavish lifestyle. Unfortunately, due to various challenges, he decided to close it down.
Benjamin Graham’s greatest regret was not the closure of the business, but rather that he did not apply his business philosophy to his personal life. His lifestyle could not endure the financial downturn, and he lacked a margin of safety.
There was insufficient buffer between his income and expenditure to sustain his lifestyle when his income decreased. He needed a lifestyle that could withstand any economic climate.
How to Calculate Your Margin of Safety (Step-by-Step)
Step 1: Analyse 6 Months of Bank Statements
It is commonly known that the more a person earns, the more money they tend to spend. In many cases, some people don’t even need to earn it; they merely require a credit facility. It is essential to ascertain whether you have a Margin of Safety. If you do, how much is it? Here’s how to find out: Firstly, print your bank statements from the last six months.
Step 2: Identify Your Financial Buffer Before Payday
If you receive a monthly salary, first identify the exact date you get paid. If you’re paid multiple times a month, pick a consistent starting point, ideally within calendar months, for easier tracking.
Next, check your bank balance the day before your income arrives and record this amount.
This balance represents your financial buffer or margin of safety, the amount you have available before your next paycheck. Any savings or additional income sources you have should also be included in this buffer.
Step 3: Can You Survive Without Income for 6 Months?
Can you live without a job?
What if you didn’t receive any income this month? What if you didn’t receive any income the month after that? Can you survive financially without using credit? What if your lack of income stretched for six months?
Work out how long you could financially survive without borrowing or using a credit facility. It could be days, weeks, or years. It could also be that you couldn’t survive a single day. How large or how small is your margin of safety?
An increase in income should always result in an increase in investing or, at the very least, saving.
The Real Debt Guy
5 Proven Strategies to Build Your Financial Buffer
Is the lifestyle you currently have built to withstand any financial downturn? Your bank account will tell you. If you have £50 left at the end of each month, you’re walking a tightrope. One sudden hiccup in your financial life may prompt you to turn to credit, leading to financial difficulties. Your Margin of Safety is minimal. If your lifestyle relies on credit every month, your Margin of Safety is negative. You are on economic life support.
Increase Income Without Increasing Expenses
It’s not always easy to increase your income, but you should always try to do so if possible. It’s essential that if your income increases, your expenditure does not. What you do with the income is key to building your margin of safety.
Invest Surplus Funds: Stocks, Property, and Passive Income
An increase in income should always result in an increase in investing or, at the very least, saving.
Avoid Lifestyle Inflation: Why a Ferrari Isn’t the Answer
Just because you earn more money does not mean you should spend more. Someone whose income suddenly rises from five figures per year to seven figures doesn’t need to buy a Ferrari. We can guarantee that because they never needed it before the increase.
If they had a margin of safety with the five figures, the margin of safety should increase. As your income increases, the gap between the cost of your lifestyle and your income should increase positively. The more significant the gap between the two, the greater the chance and the longer you will be able to survive any financial downturn that may occur in your life.
Investing your money in assets that can help it grow, such as property or stocks, can further increase your margin of safety. Also, limiting your major purchases to necessary things will further increase your Margin of Safety. Is it essential to buy a new Mercedes just so other people can see you in it?
Your lifestyle should not rely solely on your salary. Income from investments or passive sources, like rental income from properties, should fund your expenses.
What to Do with Bonus Money: Spend, Save, or Invest?
The 30-Day Rule: Let the Spending Urge Fade
Many people who receive a bonus or a sudden influx of cash look for an “exit” for that money. They look to see how they can spend it, or may have already pre-spent it on a credit card.
Whenever you receive a bonus or a sudden influx of cash, pause... Do not touch the money, not one penny. Leave it in your bank account for a month, six months, or even longer. Let the adrenaline of receiving this new money die down completely. Get used to seeing the figures in your bank account.
From Windfall to Wealth: Prioritise Long-Term Security
Only touch the money when you no longer have an interest in spending, but rather in investing or saving, thereby building your Margin of Safety.
Don't forget to read The Real Debt Guy's final thoughts below!
