When it comes to life hacks, the Pareto Principle (also known as the 80/20 rule) is one that is seriously overlooked but can have a serious impact on your life.
So what is the 80/20 rule? Founded by economist Vilfredo Pareto, the rule says that 80% of your results will come from 20% of your actions. Pareto was only using the rule for a few specific situations at the time, but it’s since been shown that it can apply to just about anything.
And you might be surprised that the 80/20 rule can even help you to improve your personal finances, as we’ll explain in this article.
What is the 80/20 Rule?
The 80/20 rule — formally known as the Pareto Principle — is a rule that states that 20% of your inputs lead to 80% of your outputs.
The principle dates back to the late 19th century with Pareto, an Italian economist. He noticed that 20% of the pea plants in his garden resulted in 80% of the pea pods. More importantly, he found the same pattern could apply to the country’s wealth distribution.
In the years since Pareto discovered this principle, it’s been applied to many other areas of life, from business to law enforcement to healthcare.
Here are a few examples of how the 80/20 rule can apply to your life:
- Your to-do list: You might find that 20% of the tasks on your to-do list contribute to 80% of your productivity, while the other 80% of tasks contribute to just 20% of your productivity.
- Your habits: The majority of our days are made up of habits, and you might find that just 20% of your habits are responsible for 80% of your results, whether those habits and results are good or bad.
- Your relationships: Some of the relationships in your life are more important than others. I try to maximize the 20% of my relationships that bring me the most joy and are most important to me.
- Your possessions: Chances are that a few of the possession in your home are the homes you use most often, while most of your possessions aren’t used on a daily basis.
How to apply the 80/20 rule to your finances
In addition to the other areas of your life where the 80/20 rule can apply, there are a few areas of your finances where it can plan an important role.
Many people apply the 80/20 rule to their budget as a way to allocate their spending. This budgeting method combines the Pareto Principle with the 50/30/20 budgeting method made famous by Elizabeth Warren.
In the 50/30/20 budget, you spend 50% of your income on needs, 30% on wants, and 20% on savings. The 80/20 budget is a simpler version of it.
Using the 80/20 budgeting method, 80% of your income goes toward monthly expenses and spending, while the other 20% goes toward savings and investments.
Of course, the 80/20 budget rule won’t work for everyone. If you’re working toward a specific financial goal, like paying off debt or early retirement, you might put more than 20% of your income toward your goal. Meanwhile, someone with a low income or in a high-cost-of-living area may need to spend more than 80% of their income on monthly expenses and spending.
If nothing else, this budgeting method is ideal for those who aren’t sure how much of their money they should be spending versus saving and want a bit of guidance.
YOUR INVESTMENT PORTFOLIO
Another area where the 80/20 rule can apply to your finances is your investment portfolio. In this case, many investors will find that roughly 20% of their investment holdings will lead to about 80% of their growth.
While these percentages won’t be exact, the general rule applies that a small number of your investments will result in the most growth. But because you can’t know ahead of time which those investments will be, it’s important to have a well-diversified portfolio.
We can see evidence of this by looking at weighted index funds like total stock market funds or S&P 500 funds. A handful of large companies make up most of the portfolio, even though there are hundreds or thousands of companies in those funds.
Another area of your finances where the 80/20 rule can apply is in your business. First, many businesses find that a small number of their products are responsible for the majority of their revenue.
Similarly, many businesses find that a small number of customers or clients are responsible for a majority of their business. I can attest to this one myself. A handful of my freelance clients are responsible for the majority of my income, while the rest of my clients bring in smaller (but still important) income each month.
A final application of the 80/20 rule in business applies to where you spend your time. Spend some time paying attention to the tasks you’re working on throughout the day. You may find that a small number of tasks are directly responsible for the majority of your income, while the majority of your tasks don’t really result in any money.
It’s amazing how changing or maximizing a minority of the actions you take in a day can have such a serious impact on your results.
Now that you’ve seen some examples of the 80/20 rule at work, it’s easy to see how it can apply to your own life and not just to your personal finances. You may find examples in your relationships, career, personal development, home, and more.
The key is identifying those actions that are responsible for the greatest results and finding ways to maximize or go all in on them.