The 80-20 Rule, also known as the Pareto principle, probably isn’t a concept you learned in high school or college. Yet you’ve been experiencing it all of your life!
Put simply, the 80-20 Rule tells us that, for any event, 80% of outcomes result from just 20% of causes. Let’s break that down to understand how the 80-20 Rule applies to your own life, and how it may be the secret weapon to taking control of your finances.
The 80-20 Rule Explained
The 80-20 Rule can be interpreted in many different parts of life, which explains why it’s such a popular management strategy. Think of it this way: 80 percent of results come from just 20 percent of your effort.
Applied to personal finance, this means that 80% of your spending originates from just 20% of your financial responsibilities. Usually these include housing, utilities, and debt. This can also be applied to grocery shopping: 80% of your grocery bill comes from 20% of the items.
By digging into the 80-20 Rule and understanding how it impacts your financial situation, you can adjust your habits to improve your trajectory.
Understanding How It Works
If 20% of your financial responsibilities demand the majority of your spending, that’s where you need to focus your attention. It doesn’t make as much sense to obsess over the other 80% of your financial responsibilities that only account for a fraction of your overall spending.
Morning coffees and occasional movie nights (pre-pandemic), for example, are relatively inexpensive indulgences. Cutting them out of your budget will deprive you of the small joys that help you push through difficult days and stay motivated, yet you won’t save more than $20 or $30 a week. Reducing your housing costs, consolidating your debt, and lowering your utility bills, on the other hand, result in major savings that matter.
Applications In Your Life
There are so many different ways to use the 80-20 Rule to influence your daily decisions.
When it comes to investing, the 80-20 Rule reminds us that 80% of your financial gains will come from just 20% of your investing effort. So identify what that 20% of effort looks like, and don’t waste any time putting it into action. Index funds and low-fee mutual funds that track the market are often the easiest low-maintenance investment options that deliver results.
When it comes to day-to-day spending, breakdown the small items that cost the most. Do you really need the name brand seltzer water, or can you switch to generic and save money week after week? Do you need the brand new, fresh-off-the-lot car, or can you save thousands with a certified used vehicle instead? These decisions have power!
See Also: The 50/30/20 Budgeting Rule