The Psychology of Money Chapter 13: Room for Error

At the battle of Stalingrad in WWII, Germany had over 100 tanks waiting to be deployed at just the right time. When that time came, less than 20 worked. Despite the best engineering, those tanks (as they later found out) were susceptible to field mice nesting inside and chewing through the wires. Would Germany have won Stalingrad, and would the war have played out differently had it not been for those mice? As Housel comments on this strange course of events, “You can plan for every risk except the things that are too crazy to cross your mind.”

There are many field mice in our financial lives—things that can happen that nobody would expect. One way to have some protection against them is by having a margin of safety, or room for error. One of the first steps of financial independence is building an emergency fund. While it can be painful to watch everyone else spend all their income while you take months or even years to pile cash up without a specific purpose, or while you watch your emergency fund grow by 0.01% while the rest of your financial assets grow by 10% (100x more), this emergency fund is one way to create room for error. While it wouldn’t have been practical (or possible) for Germany to create 6 months of reserve tanks, we can do that with our finances.

Or think about it this way: you have an 83% chance of winning Russian roulette. Despite that, I don’t recommend it become a hobby. If we have a good chance of coming out ahead, but the downside risk is too great to bear—like in Russian roulette or in putting all your money in one stock—we can never afford to take that risk.

When creating financial plans, we run what’s called a stress test. Maybe your current course of action (overall plan) has a good chance of succeeding, what we have below as the baseline, but what if one thing goes wrong? What if two things go wrong? If your plan only works if everything works, it’s not a very good plan. We find the weak points, where mice can get it, and beyond that can build a room for error for when things happen that we don’t plan for.

Success in our personal finances comes down to how we behave. Two things we can do:

1. Create room for error (build an emergency fund, spend less that you can afford to)

2. Avoid single points of failure. If one thing would completely take you out financially, don’t expose yourself to that risk at all or insure against it.

I’d love to know

• Do you feel like you have room for error, margin of safety?

Until next time, happy reading!