1. Pareto Principle  (80/20 rule)

“The Pareto principle (also known as the 80/20 rule) states that, for many events, roughly 80% of the effects come from 20% of the causes.

 

   Management consultant Joseph M. Juran suggested the principle and named it after Italian economist Vilfredo Pareto, who noted the 80/20 connection while at the University of Lausanne in 1896, as published in his first paper, “Cours d’économie politique”. Essentially, Pareto showed that approximately 80% of the land in Italy was owned by 20% of the population; later he demonstrated that also 80% of the total income in a country is earned by 20% of the population. Pareto developed the principle by observing that about 20% of the peapods in his garden contained 80% of the peas.”

“Joseph Juran, a quality expert, discovered a similar relationship, the principle of the “the vital few and trivial many”, where 20% of the activities lead to 80% of the result.

 It is a common rule of thumb in business; e.g., “80% of your sales come from 20% of your clients.”

 Mathematically, the 80/20 rule is roughly followed by a power law distribution (also known as a Pareto distribution) for a particular set of parameters, and many natural phenomena have been shown empirically to exhibit such a distribution”

  ( https://en.wikipedia.org/wiki/Pareto_principle
https://www.britannica.com/biography/Vilfredo-Pareto )

80 20 Financial Freedom applies the Pareto mindset to make things as simple as possible and to make decisions on the right level, without getting stuck in details which in the end have no material impact on the wealth building. 

 

  Ensure you have the right knowledge to get the most important decisions right, without letting yourself be derailed by all the financial services and financial products which the many suppliers would like to sell to you.

 

For the followers of Stephen Covey’s “The 7 Habits of Highly Effective People there is  clear link here with
Habit 3: “Put First Things First“.
(https://www.stephencovey.com/7habits/7habits.php)

 

 

 

In this example I will illustrate that during each phase of your wealth building 80% of the results are determined by only 20% of the choices you can make.

The message to take away is that for each phase different choices are important. Let’s progress this for following phases:

 1. Ensure you have a good and growing income, and manage your spending, so you can save money;
2. Consistently grow your wealth by saving regularly, properly managing your spending;

3. Ensure that your investment portfolio grows well, in a way which fits you;
4. Live happily and relaxed from your wealth and/or pass it on

 1. Ensure you have a good and growing income, and manage your spending, so you can save money.

 Get your education and experiences right, and find the right jobs or activities as an enterpreneur. The focus in this phase will be all about getting your earning capacity right, and about actually generating a good regular income. Only by having a good and growing income, combined with managing your spending, you will be able to save money. 

The most important choices are focused on getting a good and growing income. 

In phase 1 it is less important whether you are already investing your money, and if so how you are investing your money. As this will not have a material impact on the final wealth you are building. All is fine as long as you are saving money from your income. Often the only ‘investments’ in this phase will be the start of a pension with an employer or buying ones first home. Obviously one has to start to spend less than one earns in this phase, as otherwise there won’t be a start of your wealth building.

2. Consistently grow your wealth by saving regularly, properly managing your spending;

 

By increasing your regular saving amounts as your income rises (instead of just spending all increases in your income), your wealth will start to seriously grow. The focus will be on the prevention of so-called ‘life style creep‘ – often solved by the ‘pay yourself first‘ approach. De focus zal hier liggen op het consequent minder uitgeven dan men verdient – ‘Pay yourself first’.

 

  The most important choices are about consistently making a material part of your income available to save – where you need to manage your expenditure well.

 

 During this phase it is more important to consistently save part of your income than to get the exact allocation of your wealth right, this will in the end still have a limited impact.

3. Ensure that your investment portfolio grows well, in a way which fits you.

  Your wealth will not just grow by what you save, but also ‘money will generate money’. Your wealth, be it on a savings account or invested in company stocks, will grow itself too.

   When the amounts saved get material, it will become more important how your wealth is being allocated, to ensure your wealth grows well. At a certain moment, the growth of your investments will be determined more than the way you allocate the investments (asset allocation) for the long term than by your ongoing savings contributions out of your income.

 The most important choice is now how to best arrange your growing wealth (asset allocation), plus how to minimize the  costs of owning and managing your investments.

 4. Live happily and relaxed from your wealth and/or pass it on.

   On day you may stop to work for a living, or you may start to work only part-time. You will start to live by using your pension (if available) and your wealth and the income it generates. You will stop to contribute any savings to your wealth. The focus will change, and be about managing the risk to preserve your portfolio, while still ensuring a proper growth. You don’t have the luxury of a long time any more to manage material losses.

  The main choices will be about risks – how to ensure preservation of your wealth in a risk profile which fits you.

This example illustrates how important it is to get the focus on the 20% of the choices which – in your situation – make 80% of the difference in the wealth building. These choices differ for each phase. 

  A financial product that may fit very well in one or two of these phases, may be the wrong product for another phase.

Please note that this is just an illustration of the 80/20 approach. Many things which may be relevant were not taken into account, like the early use of tax opportunities, potential inheritances, severance payments, etcetera.

%

Focus on the most critical decisions

%

To get the right balance - for you - between wealth growth and risk

Copyright picture #1: convisum / 123RF Stockfoto, picture #2: tamara1k / 123RF Stockfoto, picture #3: pixelsaway / 123RF Stockfoto, picture #4 flynt / 123RF Stockfoto, picture #5-8,10 msharova / 123RF Stockfoto, picture #9 <a href='https://nl.123rf.com/profile_iakovenko'>iakovenko / 123RF Stockfoto</a>