The Pareto Principle: How the 80/20 Rule Can Apply to Your Money

The Pareto principle, sometimes known as the 80/20 rule, is a concept that has many applications.  The main idea is that 80% of the effects are resultant from 20% of the causes. Or put another way, 80% of the results come from 20% of the effort.  Lately, I’ve been giving some thought to how this way of thinking can be applied to our lives in terms of money.

The Pareto Principle and Business

The Pareto principle is often included in many business decisions. When working on selling a particular product, it’s generally not a good idea to try to be everything to everybody. In other words, your product will a good fit for some people, and not as good of a fit for others. Plus, there might be some potential customers that can be influenced to buy your product, and some that will be resistant to buying it.  Thus, it’s important to target sales efforts for a product (or service) effectively, so that your resources are used wisely. It’s often cost prohibitive to mass market most products.

The result: we might see that a large percentage of our sales come from a small concentration of customers. To apply the Pareto principle, we would say that 80% of sales come from 20% of customers.

Or, you could discover the following:

  • 80% of sales come from 20% of marketing channels
  • 80% of advertising-sourced revenue comes from 20% of your advertisements
  • 80% of your customer complaints come from 20% of your products
  • 80% of your productivity comes from 20% of your employees
  • 80% of your referrals come from 20% of your customers

If you’re a blogger, to take another example, you might find that a significant percentage of your referrals come from a small percentage of referring sites.

The Pareto Principle and Personal Finance

While the Pareto principle has been oft-discussed in terms of business, I think it might be underutilized in personal finance.

In terms of how we spend our time with respect to improving our financial situation, and working toward our money-related goals, there are different ways to go about it.  A common theme I see throughout the blogosphere, as well hear in conversations, is the use of money saving strategies. People come up with all kinds of ways to save a few bucks, and will frequently take interesting measures to do so.

For example, you just know there are people that would drive an extra 10 minutes each way – 20 minutes round trip – to buy gas at place that’s 5 cents per gallon cheaper. They just can’t stand the thought of intentionally paying more for gas when a cheaper alternative is available nearby. The thought of spending 20 minutes to save maybe 75 cents is quickly rationalized, if thought about in the first place.

Don’t get me wrong, I’ve engaged in some unique practices too. My idea of picking up pennies at the drive-thru might be a bit extreme , though at least I donated what I found :).  Additionally, as I’ve shown in the Squirreling Gone Wild series, there are plenty of interesting things people do to save money. There’s no shortage of wacky schemes out there!

Those schemes are often harmless and fun. Ok, admittedly (and obviously) and I get a huge kick out them:)

However, it’s when people invest a lot time into saving a few pennies or even dollars, I wonder if that’s the best use of time in terms of meeting money goals.  Now, of course saving is great, and is vital to personal finance success. You can make all you want, but if you don’t save anything, you have nothing to show for your accomplishments.  But in order to save, don’t we have to make money too? It’s all a balance.

This is where I’m going to start thinking a bit more about what’s the most impactful use of my time:

If I’m spending 20 minutes going to a certain store to save money, how much is that really yielding?

If I’m spending an hour looking for an online bank that pays $0.001% more in interest, how much extra is that really getting me?

If I’m spending all day at work trying to get a routine task perfected, how far is that getting me? Could I do a visible, value-added special project instead?

What I’m getting at is that I suspect that many of us spend a lot of time doing things that ultimately don’t yield big results.  Even when aggregated, the little wins don’t always equal the big wins. Should we be focusing on getting better ROI on our time, spending it where we can truly get results?

In other words, maybe we should apply the Pareto principle (80/20 rule) to our efforts to grow our savings and net worth.  Focus our efforts where results will happen, instead spending time on low-yield activities.

Now, I’m not saying that I’m going to let making money guide my life, or choose daily activities in this way. I’m only talking about time that’s actually spent in the pursuit of money, one way or another.  Admittedly, after some reflection, I could probably improve in this area quite a bit.

My Questions for You:

What do you think of this concept of the 80/20 rule?

Do you ever think about this in your own life?

Do you have any additional examples of the Pareto principle to share?

 

Comments

    • Squirrelers says

      BNL – seems like you’re a veteran of applying this principle. It can pay off, as it seems like you’ve observed!

  1. says

    I think the Pareto Principle is great, but it doesn’t really get the respect it deserves. Financial success, in my view, comes from utilizing even seemingly abstract concepts in your personal finances. One book that I really like is 7 Habits of Highly Effective People. After reading it, I realized how easily it would be to simply change the title to 7 Habits of Highly Wealthy People without changing a single word in between the front and back cover.

    • Squirrelers says

      JT – totally agree that Pareto principle is worthy of more attention. Also, I agree that there are plenty of concepts that could carry over to personal finance. It’s good to think broadly and expansively!

  2. says

    I too, think the Pareto Principle is great. I agree it can be applied to many things. I remember learning it in college, but I learned of it’s application towards finance by Rich Dad, Poor Dad author Robert Kiyosaki.

  3. says

    I’m a big fan of this principal too. I first heard it as “80% of your revenue comes from 20% of your customers.” Which I was working at a coffee shop at the time and it sure seemed true to me. It seems strange to think you could basically ignore 80% of your customers and only lose a fifth of your reveunes… but I guess that’s the way it is.

    • Squirrelers says

      Ashley – yes, there are high value customers and there are low value customers. Once customers are retained, they can become exceedingly valuable. It’s worth focusing on them, because it can get expensive acquiring new customers. This is just one example of the principle, among many that also carry over into personal finance.

  4. says

    The 80/20 rule is absolutely what I have built my life and career around. One of my areas of expertise is technical project management and I’m the queen of picking the 5 things that need to be completed in order to get the project 80% of the way there. Then it gets handed off to the anal detail person to finish it the rest of the way. I’m good at getting projects rolling fast and furious and 80/20 is how I do it. And also, 80% of our sales do come from 20% of our customers..that’s indeed a fact too.

    In fact, my husband is extremely detail oriented and I think having that 80/20 mentality is hard for perfectionists. However, we complement each other pretty nicely as a result. If we were both 80/20 people, we’d never finish anything, but if we were both detail people we’d never start anything.

    • Squirrelers says

      First Gen – I tend to agree with you that having an 80/20 mentality is tough for perfectionists. Like in business, when marketing a product, most of the time it’s not something that you market to everybody. You segment and target. Perfectionists in personal lives sometimes have trouble just focusing on what’s important and not worrying about the rest. They could learn from the 80/20 application in business.

  5. says

    I just picked up the book The 80/20 Person (something like that) for $1.00 at a used book sale! Can’t wait to read it. My life is mainly run by spending the most amount of time on the activity with the least amount of return….:).

    • Squirrelers says

      Amanda – cool that you picked up a book that has this concept in the title. Even better that you got it for $1 at a used book sale. Way to go!

  6. says

    I totally agree with the 80/20 rule and always try to get the biggest ‘bang for my buck’. However, sometimes I have to lower my expectations somewhat or I just get frustrated.

    I do try to focus my time and effort on things with big payoffs. Geez, even spending 20 percent of my time cleaning my kitchen can make my house like 80 percent better!

    • Squirrelers says

      Kris – I know what you mean about managing expectations. Sometimes it’s about doing what’s most effective rather than about trying to do it all.

  7. says

    I’m one of those ‘anal detailed oriented’ people. What keeps me on track with the 80/20 rule is to review and re-evalulate my goals to make sure that the details are in line with the goals.

    Details make or break a project!

    • Squirrelers says

      Marie – sounds like a good approach. Makes sense that periodic evaluation keeps us in line with what’s most important.

    • Squirrelers says

      Maggie – agreed. I once read (and was told) that it’s important to get the most important thing first. I’ve also read that it’s good to get the most unpleasant thing done first. Either way, it’s good to focus energies on what really needs to get done or is more profitable – so those things can be done very well. The rest? Do our best, even if “good enough”.

  8. Alison Cline says

    My life is mainly run by spending the most amount of time on the activity with the least amount of return….:). Once customers are retained, they can become exceedingly valuable. The 80/20 rule is absolutely what I have built my life and career around.

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