In 1906, Italian economist Vilfredo Pareto observed that 80% of his country’s land and wealth belonged to just 20% of the population. To explain this unequal distribution, he created a mathematical formula – the Pareto Principle. Also known as the 80/20 Rule, the Pareto Principle means that 20% of something is responsible for 80% of the results.
The Pareto Principle extends to our interpretation of how nature and the man-made world work. For example: 80% of a business’s sales are generated by 20% of its clients; 20% of staff cause 80% of a business’s problems; and 20% of staff provide 80% of production. Bearing in mind that the 80/20 formula is not set in stone, the ratio could be 70/30 or 90/10. But the theme is that the minority impacts the majority.
Pareto and your money
I have observed this principle in the way people manage their money. I have examined my clients’ budgets and can attest that it’s household expenses – the 20% – that get people into trouble. It’s not the mortgage; it’s not the recurring essential expenses such as electricity and rates that destabilise the household budget. It’s the spur-of-the-moment, emotional and non-essential purchases that undermine our finances – purchases such as takeaway meals, alcohol, entertainment and holidays.
Imagine if you saved and invested this 20% of your income (9.5% super + 10% personal savings). You would be building your wealth for the long term.
We can see further examples of Pareto’s Principle negatively affecting our finances:
- Most of us use only 20% to 30% of the clothes, shoes, jewellery, bags and make-up we own. The rest is worn only for special occasions, or perhaps too uncomfortable to wear at all, and remains idle in our cupboards.
- Most of the household items we own, such as towels, linen, cutlery, cups and pots, don’t get used. We find ourselves using the same towels and the same cutlery and plates. We leave “visitor sets” for when visitors show up, but 80% of the time they don’t.
- We leave 20% of our food and drinks, including milk and juices, in the fridge, unused, then throw them in the bin by week’s end.
- We keep unused food – such as tinned tuna, Spam, jam and Vegemite – in the pantry for months. We tell ourselves we’ll use these items to make a quick meal if we’re short for time, but we end up buying takeaway pizzas, burgers or Thai food. The tinned food ends up being thrown away months after expiry date.
Live by Pareto's 80/20 Principle
Wouldn’t it be life changing if you did a stock take of all the possessions in your cupboards and reviewed your inventory? Would you be surprised to find there are many items that have not been used for months, yet could still be used?
How much money would you save if you committed to not buying any clothes, bags, shoes, jewellery, make-up, towels, cutlery, plates and bed sheets for a whole year? What would you do with the savings?
Do you know how much you spend every year on building your inventory? It might be time you found out...
Susan Wahhab —CPA, SMSF Specialist, Entrepreneur, Working Mum, Small Business Supporter— is Australia’s leading Financial Strategist and Money Mentor. Susan is the founder and managing director of Accounting and Financial Services firm Winner Partnership (www.winnerpartnership.com)
Susan is the author of the transformational and practical book Money Intelligence® - Anchored in Values. She believes that people can become financially liberated by developing a healthy relationship with money. Learn more about being money intelligent www.moneyintelligence.com.au