The 80/20 Rule and Your Money

The 80/20 Rule and Your Money January 20, 2012

An Economist named Vilfredo Pareto came up with a revelation that changed the world when he discovered the 80-20 principle. It says that 20% of causes contribute 80% of the effects.

In normal people terms, it looks like this:

  • 20% of the population receives 80% of the income.
  • 20% of donors contribute 80% of the donations.
  • 20% of customers contribute 80% of sales.

It’s weird how accurate Pareto’s rule is. It applies in business, economics, agriculture, and almost every area of life.

It even works with money.

Understanding The 80-20 Rule

80-20 can be a powerful ally or a horrible revelation.

You spend most of your money on about 20% of your expenses. This could be basics like food, utilities, and rent if you’re poor or it could be something as simple as spending all your money on a hobby.

Look over your bank and credit card statements. Where is all your money going? Is it eating out? Is it bills? Is it old debts? Where is your 80-20?  What’s consuming most of your cashflow?

Like all things, the focus can either be good or bad. If a lot of your money is going towards something you love, then there’s nothing wrong with “overspending” occasionally.

I love eating out; I’d do it several times a week if I could. And because it is something I enjoy so much, I put a good chunk of my income into eating out.

You may love buying shoes, giving to charity, or collecting stamps. Whatever it is, there’s nothing wrong with putting your money into what you love.  The key is to make sure you’ve budgeted for it and prioritize ahead of time where you should spend your money.  Spend your money with a purpose; don’t lose sight of your priorities.

But there’s a bad side to the 80-20 principle. Most of us don’t decide where our money is going. Few ever check their bank statement or consider learning how to make a budget.

Instead, we buy whatever marketers tell us too.

It could be the newest smart phone, or a higher cable bill, or a million other things. Most of us spend money we don’t have (credit cards) to pay for things we don’t need, hoping to impress people we don’t like.

It’s a vicious cycle that leaves us without a plan, a hope, or a future.

What To Do

No matter who you are, there’s a good chance that you might fall into the 80-20 trap. You can either use it to pay your bills, stay out of debt, and do the things you love or you can go deeply into debt putting all your money into things you don’t care about.

The choice is yours. Make the right one.

Can you think of a few things the 80/20 rule covers when it comes to money?

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