How to Leverage the Pareto Principle

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pareto principle

The often-quoted Pareto principle was named after a 19th-century economist who observed inequality in land ownership in Italy. Just 20% of the population owned 80% of land, in Italy and overseas.

Dr Dura extended this observation in the 1940’s.

In modern-day it has become a rule of thumb to live by.

Just 20% of input usually results in around 80% of results. So for example, around 20% of employees create 80% of productivity. 20% of clients make 80% of complaints. 80% of road vehicle mortality result from 20% of causes.

It is natural to assume that each unit of effort in an endeavour should produce equal results. But this is rarely true. The most critical 20%ish of activities generally create the majority of results. Interventions targeted at areas outside the critical 20% produce ever diminishing returns.

Interventions can be targetted to improve outcomes disproportionate to the effort involved using the Pareto Principle.

The Pareto principle can optimise many areas of life. The 80/20 is not exact and the actual ratio likely varies between activities. But it is a great ballpark starting point.

Examples of the Pareto Principle Applied in Real Life

Pareto Principal Diet

The 80/20 rule diet is a sensible and balanced approach to maintaining a healthy diet, with less healthy foods in moderation. Not as sexy (or damaging) as losing 10kg in 12 weeks, but a simple rule of thumb to live by that can help many people maintain a healthier weight.

The 80/20 Rule Applied to Exercise

Similarly with exercise. If you want to be a bodybuilder, 3 hours a day in the gym with a carefully designed exercise programme and personal trainer are going to help you get that competitive edge.

For those that just want to stay reasonably fit and healthy, the 20% rule works pretty well. Riding a bike to work daily would meet the guidelines suggesting 30 minutes of moderately intense activity per day without a lot of fuss. Further exercise beyond this would make a difference, but not as much as that from going from a couch potato to a daily exerciser.

This ABS report found that less than 25% of Australian adults manage 10,000 steps in a day.

Pareto Principle & Time Management

At work, prioritization of tasks can utilise the 80/20 rule of thumb to improve your work day efficiency. In business, 80% of revenue is due to 20% of customers and 20% of tasks result in 80% of productivity.

“Doing less is not being lazy. Don’t give in to a culture that values personal sacrifice over personal productivity.”

― Tim Ferriss

How to use pareto principle in Finance and Investing

Embracing the Pareto principle can mean targeting your efforts efficiently to get the most bang for your buck. If you can find the sweet spot of most return for the minimum effort, your time and effort remain freed up.

Sweet Spot *

The 80/20 Rule in Money Management

Money management systems can be as simple or as complex as you like. The most important factor is that you avoid overdrawn fees and capture savings for investment.

Since the Publication of Scott Pape’s Barefoot Investor*, his barefoot buckets have become widely used. Empower wealth make the Wealth Portal available to anyone who wants to use it. You can document every spend every month.

Or, embracing the Pareto principle, you could simply separate discretionary from essential spending. Minimise effort and barriers to investing by utilising an automated direct debit to deliver your savings into a separate account, stock brokerage, mortgage offset or superannuation. Zero effort is required after the initial set-up, so you are so much likely to stick with it. Minimum effort, whilst reaping the vast majority of the returns associated with analysing all your spending.

The 80/20 Rule in Financial Literacy

There are countless excellent books on finance and investing. If you have time, and enjoy reading finance books here are my recommendations.

But assuming you are busy, or maybe just want to get your finances sorted without having to immerse yourself you can use the Pareto principle again.

You need 80% of the returns for 20% of the efforts. Subscribing to a blog that you resonate with will mean relevant up to date information will be delivered to your inbox in a weekly email. Subscribe to a podcast that suits you and commit to listening to it once or twice a week, and your financial literacy will increase significantly over time. With almost no effort! Or subscribe to Money magazine* to receive a physical copy monthly in the post to read with your coffee.

The Pareto Principle in Investing

One of the main deterrents to starting to investing is that it seems so complicated. Any financial news reports on several indices, multiple individual stocks, gold, oil and many more and attempt to explain the moves on the stock price that day with recent events.

Today I treated myself to Commsec’s morning report, reporting 0.4% increase in the ASX 200 on opening and warning about the potential effect of the delta variant virus on the S&P 500.

Long-term index investors know to ignore all this noise and jargon for what it is, largely entertainment for ultra money nerds. But is off-putting for beginners.

Instead of spending weeks learning a stock-picking strategy, and then trying to beat the full-time qualified professionals at their own game, you can accept market returns by investing in broad-based index funds. History tells us this will return more than 100% of the returns of active investments more than half of the time anyway.

The Pareto principle is helpful in developing a reasonable investing plan after a weekend of reading, even you are wondering where on earth to start. Sure, you could continue learning about investing for the rest of your life, but the initial 20% of effort will yield ~80% of results. You can tweak your plan and fill in the detail with extra knowledge later, or just stick with the 80%. Many do far worse.

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Aussie Doc Freedom is not a financial adviser and does need offer any advice.  Information on this website is purely a description of my experiences and learning.  Please check with your independent financial adviser or accountant before making any changes.

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