The 80/20 Principle and Money

by Tim on July 24, 2013

You’ve probably heard of the phrase “the 80/20 rule.”  The technical term for this common phrase is called the Pareto principle, named after … you guessed it, a man named Pareto.  In the early 1900s, Vilfredo Pareto noticed that 80% of Italy was owned by 20% of the population.  On a much smaller note, he observed that 20% of the pea pods in his garden produced 80% of the peas.  His observations developed into a general thought about the way things are distributed and the Pareto principle was formed.

The basic concept behind the 80/20 principle is that most of an effect comes from a small percentage of the cause.  Business consultants have used this principle to create dozens of books and suggestions as to how you should manage resources, approach sales, and handle customers.  You can almost apply the principle to any situation; so let’s see how it applies to money.

The 80/20 Rule for Side Income

I’m focusing on side income because I think it’s more applicable with this theory and because I have first hand experience with making money with side jobs.  If you’re the hustler type, you know that your time after work is limited.  By necessity, you trim down aspects of your side hustle to become more productive during your off hours.  When you do this, you’re living the 80/20 principle.  You realize that the majority of income comes from the focused work, so you ‘cut the fat’ in order to optimize the productive time.

Real life example: When I was in college, I detailed cars for extra money.  As a way to speed things up, I had my friend help me.  He was a perfectionist, so I thought he’d be good at detailing cars.  Unfortunately, while I finished an entire half of a car, he was still working on the floor mats.  He was spending 80% of his time on 20% of the goal.  Lesson: don’t focus all your efforts on the things that don’t add much to the big picture.

The 80/20 Rule for Budgeted Expenses

Think about your budget – what categories do you break most often?  Eating out?  Entertainment?  What about the uncategorized section?  You know, gadgets that don’t always make their way into a budget category.

Real life example: A couple of months ago, I bought a guitar.  No, it wasn’t in the budget, so we used money that would have otherwise gone to savings to pay for the guitar.  The expense of a guitar was easily the biggest extra expense for that month and the next, but we allowed it to happen because we were paying way too much attention to the smaller budget items such as entertainment.  The 80/20 principle comes into play here because we were giving the small things 80% of the attention and leaving the big purchases out of the equation.  Lesson: Don’t spend all your time focusing on the small stuff if it means that you’ll let the big things slide.  Redirect your energy to keeping the big ticket expenses toned down and let the small items balance themselves.

What areas of your finances can you see the 80/20 rule show up?  Have you ever given much thought to this principle at work, home, or with your budget?

Tim is a personal finance writer at Faith and Finance a Christian financial help blog that provides financial insights for individuals, businesses, and churches. Outside of finance, Tim enjoys spending time with his wife, playing the saxophone, reading economics books, and a good game of RISK or Catan. Find him on Twitter and Facebook.

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{ 3 comments… read them below or add one }

Shaun @ Smart Family Finance November 14, 2011 at 7:00 am

Great application for the 80/20 principle. I generally try and do a rough calculation on what side income would work out to using the rule. What percent of income will I earn and how much percent of income will it generate. I usually can’t get to 80/20, but I definitely won’t take up an opportunity that will go below it.

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Kyle @ EngageYourMoney.com November 18, 2011 at 7:00 pm

I’m a big fan of the 80/20 Rule. I’ve found that it works in pretty much every aspect of my life, especially school work. For example, I was perfectly fine studying for a short amount of time in college and being in the 80th percentile while also enjoying the other aspects of college. You know that they say, ‘A students make great professors, B students make great managers, C students make technical lead.’”

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Financial Independence November 29, 2011 at 4:30 am

I think we all agree that 80/20 rule is unlikely to be applied in hospitals, dentist’s office, with the money manager?

However it is exactly what they do – concentrate on the profits, and perhaps that is why where we are? Top 20% are doing just fine : -)

Perhaps it is life.

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