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?