How the Pareto Principle Applies to Investing (80/20 Rule)

What is the Pareto Principle?

The Pareto Principle, otherwise known as the 80/20 Rule, states that the majority of outcomes are caused by a minority of causes.

Originally the Pareto Principle referred to the distribution of wealth, however, it can be applied to a wide variety of contexts. Here are the top 3 ways to apply 80/20 thinking to your finances and investing.

Take Control of Your Finances

When it comes to money, most of us switch off. We don’t keep track of what’s coming in and what’s going on. But left unchecked, money disappears. It slips through our hands like water.

Fortunately, the days of collecting receipts and inputting them to a ledger are long gone. There are now simple, easy and intuitive ways to keep on top of your money.

There are apps to help you keep track of your finances, like Money Dashboard, Moneyhub and YouNeedABudget. Banks have also upped their game, with the likes of Starling, Monzo and many others providing expense category tracking. Or, if you prefer simplicity, we’ve produced our own 1-page expenses sheet.

Having a clear understanding of what’s coming in and what’s going out gives you control and clarity over your finances. An hour a month gives you peace of mind and may help reduce your spending on things you don’t really value.

Pay Your (Future) Self First

Saving for the future is tough. It requires making a conscious trade-off between our current wants and our future needs.

Whilst we know saving is important, it’s difficult to do ‘in the moment’. It requires putting money away for some unknown future, at the expense of living for today.

The best way to save for the future is to pay yourself first. Each month, when you get paid, set up a standing order to your savings and investment accounts. Importantly, do this at the start of the month.

This will make saving much easier. No more daily battles about what you should and shouldn’t be spending. Whatever’s left over after savings and bills is yours to enjoy.

There’s more than an element of truth in the phrase ‘you don’t miss what you don’t have’.

Make Smarter Investment Decisions

If you read the media, you’ll be forgiven for thinking that investing is all about picking the right investments. Or getting in and out of the market at just the right time.

But that’s rubbish. To be a successful investor, you just need two things – (1) a low-cost, well-diversified investment portfolio and (2) patience. This is best illustrated with a short story…

In 2008, Warren Buffett challenged Protégé Partners, a legendary hedge fund manager to a competition. They would both invest $1m for ten years and see who could deliver the best performance.

Buffett invested his money in the S&P 500, a low-cost index-tracking fund (the US equivalent of the FTSE100). He didn’t make any changes, no buying or selling.

Protégé handpicked a portfolio of high-cost hedge funds. These were run by experienced investors, who tried to get in and out of the market with precision. They used various sophisticated strategies and asset classes.

So how did they compare? At the end of ten years, Buffett’s low-cost simple investment was worth $2.2m. By comparison, Protégé’s high-cost sophisticated investment was worth $1.36m.

As ever, if you want a helping hand, either drop me a line or schedule a meeting.

All the best,

James Mackay, Independent Financial Adviser in Bristol

Financial Advisor Bristol and Pension Advisor Clifton

Frazer James Financial Advisers is an Independent Financial Advisor based in Clifton, Bristol.

About us: Frazer James Financial Advisers is a financial advisor, based in Clifton, Bristol. As an independent financial adviser, we’re able to provide independent and unbiased financial advice. We provide independent financial advice, pension advice, investment advice, inheritance tax planning and insurance advice.

If you would like to speak to a Financial Advisor, we offer an Initial Financial Consultation without cost or commitment. Meetings are held either at our offices, by video or by telephone. Our telephone number is 0117 990 2602.

Frazer James Financial Advisers is located at Square Works, 17 – 18 Berkeley Square, Bristol, BS8 1HB.

This article provides information about investing, but not personal advice. If you’re not sure which investments are right for you, please request advice.

Remember that investments can go up and down in value, you may get back less than you put in.