MAKE MONEY ONLINE POSTS: Personal Finance and the 80/20 Principle

الجمعة، 23 مارس 2018

Personal Finance and the 80/20 Principle

Several years ago, I had a brief period where I looked at my life through the “80/20 principle,” which culminated on The Simple Dollar with this brief article and a review of a still-excellent book on the topic. Eventually, the 80/20 principle became one of many arrows in my quiver of understanding the world and being as successful in it as I could be.

Before we get going, what exactly is the 80/20 principle?

The Pareto principle (also known as the 80/20 rule, the law of the vital few, or the principle of factor sparsity) states that, for many events, roughly 80% of the effects come from 20% of the causes.

Here are a few examples of this in everyday life, in things I’ve observed recently in my own life.

80% of the enjoyment I get from reading books comes from about 20% of the books I read. (The problem, of course, is that it’s hard to tell whether a given book is in that 20% of “really good books” or 80% of “mediocre and forgettable books” until I’ve read most of it.)

80% of the value I get out of my smartphone comes from about 20% of the time I spend on it. Much of the time I spend on my phone really isn’t very valuable time.

I wear the same clothes over and over; 80% of the time, I’m wearing clothes that come from only 20% of my wardrobe. I honestly wear the same handful of shirts and pants almost all of the time.

The vast majority of the wear on the carpet in our house is in only a small portion of the area which, according to my calculation, is pretty close to 80% of the wear being on 20% of the carpet.

You’re getting the idea by now, I’m sure. 80% of the effect of something comes from 20% of the cause. 80% of book-reading joy comes from 20% of books. 80% of the value of smartphone use comes from only 20% of total smartphone use. 80% of my time is spent wearing only 20% of my total wardrobe. 80% of the wear on our carpet shows up on only 20% of our total carpet. Over and over again, it shows up.

Here’s a nice little corollary for that 80/20 principle: Quite often, when you realize that you’re getting 80% of the value from 20% of the item, you can figure out ways to get rid of that remaining 80% that doesn’t provide much value. At the very least, you can drastically cut the amount of time or money you invest in that unproductive 80%.

Let’s jump back to the observation I made about books. “80% of the enjoyment I get from reading books comes from about 20% of the books I read.” Given that I observed this, it makes the act of purchasing a book I haven’t read seem like a less than sensible gesture. There’s a 4 in 5 chance that I won’t deeply enjoy it and I’m unlikely to ever read it again. If that’s the case, why am I buying it? The 80/20 principle says, “Borrow books unless you know you love that book, because there’s a very good chance you just read a book once and forget about it.” For a avid book reader, that’s a pretty big money saving principle.

Let’s apply that to eating out. If 80% of my food-eating pleasure comes from just 20% of the meals I eat, it makes sense to eat really minimal most of the time, consuming low cost, simple, and healthy stuff at home – forgettable things, basically – and just enjoy the occasional really good meal without worry. The 80/20 principle says, “Eat simple, healthy meals most of the time and eat a really nice meal that you truly enjoy perhaps once a week or so.” Again, that’s a pretty big money saving principle.

You can apply it to things like ordinary treats. If 80% of the overall pleasure you get from, say, getting coffee at coffee shops comes from just 20% of the visits, what that means is that a lot of the visits to the coffee shop are done on impulse and without strong desire or anticipation. The visits that follow a pattern of, “Oh, I’m right here by that coffee shop, might as well grab a treat” are ones that don’t bring much pleasure for the cost, so they should be dropped. Save your coffee shop visits for your biggest cravings, or for when you’ve planned ahead a little for it. The 80/20 principle says, “Save treats for the moments when your cravings are especially big or when you’ve planned ahead for it, and ignore little cravings.” Once again, it’s a pretty big saver, as you’ve eliminated roughly 80% of your splurges, but you’ve only lost 20% of the pleasure.

If you watch for it, it pops up over and over again.

The 80/20 principle is why I switched to using a soap pump in the shower, since 80% of the cleaning comes from 20% of the soap use. All I really need is a single squirt from a pump to really get myself clean, but if I dump soap everywhere, I end up wasting most of it. A pump container lets me get just the right amount – say, 20% of what I would otherwise use – and it gets me 80% of the cleaning that dumping tons of soap would get me. A second pump, if needed, finishes the job, and I’m still using way less soap than before to get just as clean.

The 80/20 principle is why I’ve cut my hobbies down to basically three things – reading books, hiking/walking/biking, and playing board games. I don’t watch television or movies any more unless it’s part of a “date night” with my wife (i.e., marital bonding) or a “family movie night” (i.e., parental bonding). I still engage in a lot of food preparation tactics, but it’s merely in an effort to simply make nutritious meals efficiently and cheaply (i.e., household tasks, personal health). If I’m lamenting the amount of time I have for a hobby, it means I need to cut out other leisure time uses. Someday, I might change those hobbies, but right now, I finally feel like I have adequate time to devote to those hobbies.

The 80/20 principle is why I’m currently rapidly downsizing my board game collection. 80% of the joy I get from playing games comes from 20% of my collection, which is an indication that I really can downsize my collection. If my collection is sufficiently large and 80% of my joy comes from 20% of my collection, that means there’s a large set of games that produces a relatively small portion of my joy, so I might as well trade off and sell those games, right? That money could be used to eventually buy other games or to invest in other things in life.

In the end, there’s a simple principle underlying all of this: In almost everything in life, 80% of the value comes from 20% of the cost. It is extremely worthwhile to look at every situation in your life where you’re spending time or money or energy to seek out where that 80% of the value is coming from and to see whether it makes sense to figure out how to cut back seriously on the time and energy and money investment without touching that 80%.

So, here’s an obvious question: If you keep repeatedly applying this principle, don’t you eventually end up deleting everything? I mean, if I keep applying it over and over to my board game collection, don’t I eventually end up just having one game – the single game that’s my favorite – and ditching everything else? The same is true for almost every application – if you keep applying it over and over, you eventually cut to virtually nothing.

Here’s the thing: Once you realize that you’re making deep, meaningful, painful cuts, it’s time to let things breathe a little. If I apply the principle to my book collection, for example, the first pass through will be easy. It’s easy to see which books I’ll probably never re-read again and so it’s easy to box them up to put into local Little Libraries or to donate them to the local library for a book sale. It’s when those decisions get seriously hard and painful that indicates that I should stop. Often, if I’m being really honest with myself, that first pass ends up eliminating a healthy majority of that collection – the less-used 80% or so.

Now, even with that remaining 20% of my games, I’m still probably getting most of my joy from a small handful of what remains, but the remaining numbers still bring me enough joy that it hurts to cut them.

In other words, the 80/20 principle is mostly just good for removing “dead weight.” Use it when you perceive that you just have way too much of something or you’re spending way too much money or something. Use it when you see bloat, or when you are struggling to balance things.

When you find that it’s telling you to cut things that are really important to you, it’s time to stop. You’ve cut the bloat, which is really the reason to consider the 80/20 principle. It’s a guideline, really, telling you that most of what you’re considering for the first time is probably bloat that isn’t bringing you much value.

In the end, it’s a really good idea to take the 80/20 principle through the areas in your life that feel bloated, where you have a sense that there’s just “too much,” or where you feel like you’re trying to jam too much into boundaries of time and money. You’ll find, almost every time, that 80% of the value you’re getting from this comes from 20% of the stuff, and that realization makes it much easier to start making big cuts and building a life that makes personal and financial sense.

Good luck.

Related Reading:

The post Personal Finance and the 80/20 Principle appeared first on The Simple Dollar.