What is the 80-20 rule in finance?
It directs individuals to put 20% of their monthly income into savings, whether that's a traditional savings account or a brokerage or retirement account, to ensure that there's enough set aside in the event of financial difficulty, and use the remaining 80% as expendable income.
You may think of the 80-20 rule as simple cause and effect: 80% of outcomes (outputs) come from 20% of causes (inputs). The rule is often used to point out that 80% of a company's revenue is generated by 20% of its customers.
The 80/20 rule, also known as the Pareto principle, suggests that a small number of causes (20%) often lead to a large number of effects (80%). In the context of fundraising, this principle suggests that a small number of donors (20%) may contribute the majority of funds (80%).
The Pareto Principle in business refers to the way 80 percent of a given business's profit typically comes from a mere 20 percent of its clientele. Business owners who subscribe to the 80/20 rule know the best way to maximize results is to focus the most marketing effort on that top 20 percent.
The 80/20 rule says that you should first set aside 20% of your net income for saving and paying down debt. Then split up the additional 80% between needs and wants. When using the 80/20 rule, calculate the amounts based on your net income - everything leftover after you pay taxes.
The Pareto principle states that for many outcomes, roughly 80% of consequences come from 20% of causes. In other words, a small percentage of causes have an outsized effect. This concept is important to understand because it can help you identify which initiatives to prioritize so you can make the most impact.
80% of your weekly tasks affect 20% of your future. 80% of grief is caused by 20% of people in your life. 80% of alarms will be set off by 20% of potential causes. 80% of the energy in a combustion engine produces 20% output.
The 80/20 rule can be helpful when planning for retirement or the long term. For instance, if you're investing for retirement and have a long time horizon, say 10 years give or take, then focusing on just one investment strategy may lead to more success than working with multiple strategies simultaneously.
The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings. The savings category also includes money you will need to realize your future goals. Let's take a closer look at each category.
The Pareto principle, also known as the 80/20 rule, is a theory maintaining that 80 percent of the output from a given situation or system is determined by 20 percent of the input.
Does the 80-20 rule apply to companies?
To identify profitable products
Many businesses offer multiple products or services. Applying the Pareto principle, 20% of these products may produce 80% of total sales. This information can help your strategic plans and marketing campaigns.
- ~20% of seeds planted result in 80% of the flowers.
- ~20% of the world has ~80% of the wealth.
- ~20% of occupational safety hazards lead to ~80% of the injuries.
- You wear ~20% of your clothes ~80% of the time.
Disadvantage: it only applies to the past
Although it can be a useful rule-of-thumb when planning, it doesn't make projections for the future. While past performance can be a good indicator of future performance, it's not always relevant.
The more you let others do for you, the more you can meet with your clients, expand your knowledge and grow your business. Remember: The goal for your time is 80% with clients, 15% expanding your knowledge and sphere of influence and 5% focused on your team, not 20% with your clients and 80% doing everything else.
- Identify all your daily/weekly tasks.
- Identify key tasks.
- What are the tasks that give you more return?
- Brainstorm how you can reduce or transfer the tasks that give you less return.
- Create a plan to do more that brings you more value.
- Use 80/20 to prioritize any project you're working on.
Warren Buffett once said, “The first rule of an investment is don't lose [money]. And the second rule of an investment is don't forget the first rule. And that's all the rules there are.”
The 70/30 rule is simple: put 70% of your income towards living expenses and 30% towards debt repayment or savings.
- Pay off debt. ...
- Build an emergency fund. ...
- Max out your retirement accounts. ...
- Invest in an index fund. ...
- Invest with a brokerage account. ...
- Invest with a robo-advisor. ...
- Invest in fine art. ...
- Invest in real estate.
Are you approaching 30? How much money do you have saved? According to CNN Money, someone between the ages of 25 and 30, who makes around $40,000 a year, should have at least $4,000 saved.
- 50% for mandatory expenses = $2,000 (0.50 X 4,000 = $2,000)
- 30% for wants and discretionary spending = $1,200 (0.30 X 4,000 = $1,200)
- 20% for savings and debt repayment = $800 (0.20 X 4,000 = $800)
How to budget $5,000 a month?
Consider an individual who takes home $5,000 a month. Applying the 50/30/20 rule would give them a monthly budget of: 50% for mandatory expenses = $2,500. 20% to savings and debt repayment = $1,000.
It says that on average 64% of your sales comes from 4% of your customers. And this rule doesn't only apply to sales. It's the way everything skews. Like a law of nature.
80% of your needs are being met by your partner, and you're figuring out the other 20% on your own. When the 80/20 rule is applied to infidelity, the theory is that when someone cheats, they're attracted to the 20% in someone else that they were missing from their partner.
A federal court just refused to block the U.S. Department of Labor's infamous 80/20 rule, which applies to employers that take the tip credit toward their minimum wage obligation under federal wage and hour law – which means now's time to ensure you're in compliance.
Vilfredo Pareto, an Italian economist, “discovered” this principle in 1897 when he observed that 80 percent of the land in England (and every country he subsequently studied) was owned by 20 percent of the population.
