The Pareto Principle and your finances
October 8, 2017 - 5 minutes read
Posted by Claire Parker
I am fascinated by an Italian called Vilfredo Pareto
Born in 1848, Pareto was an economist obsessed with efficiency.
He argued that “80% of the outcomes of something generally comes from 20% of the the causes”.
This later famously became the “Pareto Principle”. Sales people have used it for years to describe that 80% of sales often came from 20% of their customers.
The lesson from Pareto?
Focus on the 20% to drive efficiency and optimal returns.
I have recently seen books such as the “4 hour Work Week” by Tim Ferris and many others about the efficient use of your time and energy focus on this overriding principle.
It got me thinking – what is the 20% that drives 80% of returns when it comes to your finances?
I have been pondering this for a while (as you do if you are a finance geek) and I wanted to give my opinion on what I think the 20% is.
I am even going to break it down into 3 really easy steps;
Know your financial situation
Most people don’t know where they currently stand.
Don’t ask me why but life gets in the way.
I am not judging those that don’t but just understanding your current financial situation gives you such an advantage when it comes to your finances.
You can hack this part these days using some of the new technology out there such as Moneydashboard, YNAB and the new waves of banks such as Starling Bank or simply filling in a spreadsheet with the following:
You could write it all on one page and track the number every quarter.
I am telling you that this is extremely underrated when it comes to your finances. Even if you are worried and you have debt, put it all on one page and suck it up. Know where you stand financially including what you earn and what you spend.
Cut costs or earn more
I love talking about this. For some people saving is easy.
Cutting that latte at Costa or getting your clothes from ebay comes as second nature. There is a huge band of people out there who can cut costs and save for fun. They even like telling you how bad things are going to be for you, if you don’t save.
I say well done to those people but I am not one of them and I enjoy spending money on my children and Amazon (I think I am addicted).
There is another way – earning more (or getting a big windfall). I have huge respect for Ramit Sethi’s work and he gets it as he puts in this brilliant blog Lol at this Avocado Toast advice from a millionaire .
The easiest way to drive your finances forward is to earn more! Every day we are faced with a choice and our brains are not wired to resist all the short term goodies we are surrounded by such as new Iphones and Sonos speakers.
Look at how many people fail on their diets and fail to save – the stats back up the science. Its hard to restrict – not impossible but hard.
This blog is for digital and tech entrepreneurs and I am telling you that if you are going to succeed with your family finances, you need to earn more or get that big windfall. You need to know what your number is and you need to drive your career or business towards this goal.
Be wary of the spending creep – i.e. the more you earn, the more you spend. You need to invest your extra earning in your future which is why all my clients have a clear financial strategy (including the numbers).
Invest simply (once you have removed debt)
Here is a story – you might have heard this one before;
In 2008, Warren Buffett issued a challenge to the hedge fund industry, which in his view charged exorbitant fees that the funds’ performances couldn’t justify. Protégé Partners LLC accepted, and the two parties placed a million-dollar bet.
Buffett has won the bet, Ted Seides wrote in a Bloomberg op-ed in May. The Protégé co-founder, who left the fund in 2015, conceded defeat ahead of the contest’s scheduled wrap-up on December 31, 2017, writing, “for all intents and purposes, the game is over. I lost.”
Buffett’s ultimately successful contention was that, including fees, costs and expenses, an S&P 500 index fund would outperform a hand-picked portfolio of hedge funds over 10 years. The bet pit two basic investing philosophies against each other: passive and active investing.”
Source – Investopedia
When it comes to investing. What the market doesn’t tell you is that simple works. If you believe in capitalism, have a long time horizon before you touch the money and are willing to hold steady when markets go down – then you will be rewarded by investing in a simple way – you can see what I put my money into here along with a few other free pointers the finance industry doesn’t want you to know about
Investing isn’t and shouldn’t be rocket science. Equities go up over the long term and all the best investors know this.
When it comes to investing keep it simple, watch your costs and ignore the noise.
Summary of the 3 steps
3 very simple steps that take probably 20% of the effort (or less) that drive at least 80% of the returns for personal finances.
- Find out where you are financially
- Cut expenditure or earn more (preferred)
- Invest simply
What isn’t in the 20%?
Here is a brief list of what I see people spending time and effort on that don’t drive 80% of the returns:
- Reading the Money and Finance section of the media – they don’t care about your finances
- Best buy lists for some of the investing platforms – do you actually have the time and energy to manage your own investments and most of these lists are garbage.
- Listening to “unregulated experts” – the bloke in the pub, the in-laws, the “guru’s” on tv and radio that only care about their Twitter followers, not your money.
- Chasing “shiny new things” – the current trend is Bitcoin aka gambling I think
- Spending so much time worrying about money that they don’t actually get started – I wrote about this here
The most important step is to take control yourself. You can easily achieve financial independence with a fairly minimal amount of effort. You just need to get started. If you feel that you want a nudge to start things off just drop me a line