What Is the 80/20 Rule and How Is It Best Applied for Finance?
Written by
Chris Adam
Edited by
Daria Uhlig
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Who doesn’t want to make more money with less effort? That’s where the 80/20 rule can come in handy.
Also known as the Pareto principle, it asserts that 80% of consequences result from 20% of causes.
“We’re talking about a life-changing principle that the world’s best and brightest entrepreneurs seem to understand intuitively,” Nathan Chan, who started the website Foundr, wrote on the company’s blog.
Budgeting
Use the 80/20 rule for budgeting if you’re ready to manage your money and prioritize saving.
As OppLoans, explains, you divide your after-tax income into the two categories of savings and everything else. Instead of tracking every dollar or coming up with complicated expense categories, you simply use 20% of your income to pay yourself and then you can spend the remaining 80% on things you need and want.
Investing
When it comes to investing, the 80/20 rule asserts that 80% of your investment returns — or losses — come from only 20% of your assets. You should take this with a grain of salt — it’s definitely not a scientific rule, and it’s impossible to predict if your investments will behave that way. But the rule can inspire you to analyze your investments to find the best and worst performing, and adjust your portfolio accordingly. But remember — a diversified portfolio is key to reducing risk.
Retirement
You can use the 80/20 rule to leverage compounding returns on your retirement savings. The money you put away in the first several years has a major impact on the amount you ultimately save. Putting off contributing to your 401(k) or individual retirement account for just a few years can cost you tens of thousands of dollars in investment gains by the time you reach retirement age.
In all of these areas, it’s important to remember that the 80/20 rule is a guiding principle. It doesn’t take into account specifics about your life or situation, so remember to apply it in a way that makes the most sense for your situation.
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