The 80/20 rule

Sean and Ben discuss the 80/20 rule, or the Pareto Principle. Italian economist Vilfredo Pareto observed in 1906 that 80% of the land in Italy was owned by 20% of the population. He looked at other nations and saw that the ratio was the same. 

Transcript

Sean 0:00

So today we're going to talk about one of our favorite topics. The 80-20 rule. The 80-20 rule. Also known as the Pareto principle. So, Ben, what's the deal with the 80-20 rule?

Ben 0:16

Well, it's not perfect science, but you can live by it. Generally works out in a lot of concepts that I've seen.

Sean 0:25

Yeah, so the gist of it, I guess I would describe as in any population or statistics or group of things, whether that's people, places, things, money, 80% of the total impact or results or mass quantity is represented in 20% of the of that population. So if you got 10 people, two of the people wind up having 80% of the stuff, whether that's uh talent, uh work that's accomplished, money, uh anything that's not a finite physical thing like height or weight tends to lend itself to the 80-20 rule. And I don't have the history in front of me, but I believe uh Mr. Pareto, who was the first observed it in nature, um, he was looking at, what was he looking at? I don't remember what I don't remember what he's looking at, but it it it's basically social dynamics and many populations, but it was first observed in nature. So we talk a lot about it in how to run the business, but it's very important in personal finance in general as well. Yeah, agreed.

Ben 1:41

So a lot of times we're looking at our business and looking at the metrics, key performance indicators, and we want to run the business efficiently and you know, that type of thing, but I feel like this works out with just general life principles with relationships, workouts. So I guess we're gonna get into that.

Sean 2:04

Yeah. One of the things that all of us have to decide is how to use our time. So a lot of the daily activities that we have to do, or either have to do, or just do it because you know we're defaulting to it, whether that's scrolling on our phones or uh wasting time watching lots of TV or whatever the whatever however we spend time that we might objectively look at ourselves and say, ah, that wasn't the best investment of time. You know, time's the most limited resource that most of us have, right? So the 80% uh 80-20 rule, one way we can help use it to help improve our overall life satisfaction would be to say, okay, what are the things I get the most either satisfaction or happiness or utility out of, and make sure I do those first. So in a lot of ways, it can be a time management uh approach so that if if um if I need to eat healthy, make sure I spend the first things I focus on are buying the right groceries or carving out the time to prepare it in a healthy way. Or if I'm eating out, um making sure I know where to go to get reasonably healthy food versus the waiting to the last minute and then finding that I had to get fast food, which may be uh cost effective and uh tasty, but not necessarily the healthiest. So it's basically putting first things first is another way to express uh how to use the 80-20 rule to our benefit. Um so you know, eating healthy would be one way to do that, uh, one area. I don't know what's another one, Ben.

Ben 3:37

Yeah, so the thing where I think about this the most is workouts. So, and I'm as guilty of this as anybody else. So, whenever I first wanted to start working out about five years ago, I did all this research, and I'm thinking, okay, which workout is gonna be the best? How can I, you know, maximize my time? So I did all this research on which workout, which equipment set, and as you know, I I um I have a tonal now, but whoa, yeah, what's a tunnel? Tunnel's a nice little workout machine. So, you know, I settled on that eventually, but I spent probably four months. Like, what should I do? Gym membership, and then at a certain point you realize like I just spent four months researching this, and I didn't run or do any push-ups or no chin-ups. There's there's nothing that I did that actually helped me. And you know, I was focusing on the 80% of things that don't actually matter because in working out, the thing that actually matters is just showing up and doing the work. It's not rocket surgery, right?

Sean 4:48

Yep. Yeah, the working out is the the key part of the working out. Yeah, it's uh funny how that works. Um, you know, we see that a lot in what we do with people uh or read in the in the wider world. So it's easy to get caught up in what's the hot thing to do, either something to invest in or some app to use, or anything else about um financial planning. But a lot of the basics that led people to be our best clients, or on the way to being our best clients and being financially independent, are the doing those simple things, moving, you know, comparing it to food and working out, they're consuming fewer calories than they eat, right? So the the 80% for people being financially successful are usually things like spending less than you make, um, increasing your income to help that. So if you're you're young, especially, and you're trying to figure out how to be financially independent, one of the biggest and best investments you can make is your own skills and your career to improve them to be compensated more. Because if if you can make more money, your spending can remain the same and you can still be better off and obviously financially independent. Um what other things will we put in that 80% besides spending less than you make? You mean the 80% of results? Yeah, they get the 20% of things that get us the 80% of results.

Ben 6:16

Yeah, so uh taxes. So we there are certain things that we can't control, like government policy or um uh what's another one? The financial news, markets. We can't control that kind of thing. But we can control being very tax efficient. We can control costs, internal costs of funds, we can control um you know how our goals, how we look at our goals and things that we're we're trying to do in the future, we can plan appropriately. We there's a lot of things that we focus on on the 80% that just don't matter at all. And and a bunch of clients see those things as shinier, you know, like it's I'm gonna find the next Amazon. Well, that's a way of focusing on things that that aren't as sexy. I've said that before, they're not as sexy, but you're trying to avoid the hard work of doing the boring things. Like, I don't want to do push-ups, I don't want to, you know, go out and run or walk. For me, it's more like walking.

Sean 7:23

Same, same. Yeah, the the when someone is uh working, hopefully early in their career, if they have access to a 401k plan, for example, um it's natural to want to analyze the funds and figure out what's the best funds and how you're gonna make the most money, but uh guess what doesn't matter if you're not in the plan, what you're invested in. So step one and step two and step three should be get in the stinking plan, get the match, and turn it on. And that's what will drive the results, especially if the first you know 10, 15, 20 years of an investing career is getting the money in there. Um, especially if you have a match, you're gonna be better off putting it in a money market, making very little money, or maybe a little bit more these days, but a money on market fund with no growth potential or little growth potential, if you have a match versus not getting around to setting that up. So, I mean, one thing I love about personal finance is if you do uh set things on automatic while they're hard to get going sometimes to make time to set it up, the the automation can be your friend once you get it working for you. You know, it's it's not the it's not the you don't have to sweat. You just sign up for the gym membership and you're done. Uh unlike working out where you have to, in theory, actually sweat.

Ben 8:43

Yeah, I I totally agree with that. I was just thinking it's in other ways investing, it's like planting a tree, and you don't go watch it grow, it just grows. So, like that's kind of the beauty of putting things on automatic, you know, kind of nature takes its course after you kind of do the upfront initial work. That's the 20% of things that you can control right now that will give you 80% of your results. Don't watch the tree grow. You know, for investments, it's you you're not trying to find the next Amazon, do all this market research, and certainly you can hit home runs if you get lucky, but that's you got to get lucky to do it. Right.

Sean 9:23

And then a harder one, especially as you've accumulated some assets, and this gets to be a challenge for people as they approach retirement sometimes, because um it's natural to think of the end of your working life as the end of something, right? Not as the beginning of something. When really, if you're in your 60s, for example, you may have 20 to 30 years time uh life expectancy. So while it's natural to get tend to be want to be more conservative as as you get close to retirement, we encourage people to still look at, at least for part of their money, the time horizon might be much longer than they think because we're looking at their life expectancy, keeping up with inflation, etc. So in the younger years of investing and planning, a big, big thing we can do in that 20% of most impactful uh activities is to really focus on the correct time horizon. So if you're saving for a house down payment that is in the next year or two, don't invest the money to be exposed to the market because it's just not worth the potential gains, probably. Because if you're gonna need the money in the short term, you need to have it in short-term instruments. On the flip side, if you're in your 20s or 30s, if you're investing for a retirement that is 20 to 40 years away, what it does today or next year, the year after really shouldn't matter if you have a quality investment plan. So once you have a quality investment plan, a good strategy in place, try to just not worry about it. Try to think of it as where is the money going to be 30, 40 years down the road. And that should over time help you focus on increasing your income, being saving more, being smart with your spending so that you can fund that long-term account more as consistently or more consistently. And it's amazing that the people we work with or have talked to, uh talked to potentially worked with that get hung up on the day-to-day, month to month versus those who can look at the appropriate horizon. How would you describe the difference in those people?

Ben 11:23

Well, and the way I'll just say this first the way we look at that is buckets, or the way that I try to explain this is you've got your short-term, mid-term, long-term buckets, and certainly having an emergency fund that you're not sweating what the market is doing with it is important. That's mentally important to help you get through the ups and downs of the market. And as you age, that bucket might get bigger, or you might hold that bucket inside of a retirement account. It doesn't have to be that it's always outside of a retirement account. But so um I look at that as buckets so that you mentally account for what is short-term money, what's long-term money, and that kind of helps people because you don't have to be all or nothing. You don't have to be all in the market, not all in the market. Um, and now I've forgotten your question. So we're we're gonna go.

Sean 12:13

It's people that are able to focus on that appropriate horizon that understand the buckets versus people that are just looking at things on this day-to-day. Right, account value.

Ben 12:22

What is my account value yesterday versus today?

Sean 12:24

Right.

Ben 12:24

Right. Yeah.

Sean 12:25

How would you describe how those people like what's their outlook, how are they feeling?

Ben 12:29

How does it make them feel people that have the long-term outlook are happier? That's just the long and the short of it. They they can see that day-to-day activity in their accounts just does not matter as much as they as other people think that it does, so they're happier.

Sean 12:47

Yeah. And the the news uh of any kind, but financial news in particular, it's so easy to to use the what the market did on a given day, week, month, or year as this some scoreboard, like it's a like it's a sports league. Uh, I love the headlines that say market tries to bounce back from two-day losing streak. Like there's no scorecard of like, oh, they're they're third in the standings now because the two days they they lost, and now they're trying to get back. It doesn't work that way. It's it's compounding. You only get the good stuff. It's uh one of the other ways that this can apply in terms of decision making for overall life satisfaction, I think, is the time you spend with certain relationships, right? So we've all had situations where we end up spending more time and energy and attention than we'd like to in a certain class or with a certain person or group of people, and it can be difficult to extract ourselves from that. But if you really look at where you get the most out of something, you really enjoy it, you look forward to it, especially relative to what you put into it. I think that's a another great way to to use the 80-20 rule to your benefit.

Ben 13:56

Agreed. Yeah. So for yeah, most people that's keeping their spouse, you know, and their kids happy. Um it could be your extended family. For me, it's golf.

Sean 14:09

Yeah. I mean, if if you are playing basketball and tennis and soccer and running and playing golf, but you realize I like golf. I like the people, I like what then play more golf and do less running. Always do less running. That's my theory. But certainly focus on, and that could be, you know, people at work. If you get uh, you know, Ben and I are lucky enough that uh not very often that we get beaten down by our co-workers. Um but if we do, we just go to our own separate offices. For those of you that work in an office or are necessarily around other people, you know, do your best to learn to say no, learn to say, okay, I've got to go now, or okay, I'll let you go. You know, use take that time back so that you know you're spending time with the people that are best for your enjoyment or uh investing in your career, or you know, you've got to focus on the relationships that give you the most, not not just being in a selfish way, but but hopefully, you know, you're contributing. Hopefully, the people you spend time with feel that way about you, either professionally or personally. And that can be hard. Um there's a book a few years ago that uh James Altecher read called The Power of No. Basically, how to how to say no and you know, use that to uh reduce your obligations that you don't feel are are worth the investment.

Ben 15:31

And unfortunately, sometimes for us that means we say no to clients, um not our current clients, but when we're talking to people, we cannot help everybody. And there's just a finite time that we we have to work with, and so we try to help the people that we can help, and we have to say no sometimes, so that that happens.

Sean 15:51

And we've gotten better about um over the last several many years about making sure we know who who we can do the best work for, right? So kind of where's that fit? Just like again, just like any relationship, it needs to be good for both parties, and there has to be a fit. Um, you wouldn't pick just any random person as a roommate, or you may never want a roommate at all, but that's sort of the point, is you need to know what's best for for you. And that goes uh for us as advisors, as professionals, you know, we are are in a lucky position where we get to choose who to work with as long as those the other party has chosen to work with us. Um and so a lot like dating. Very much so, very much so. Um and yeah, the the other part of that is um what we spend our time on is advisors, right? So we're not looking, we're trying not to look at the noise of the markets in the very short run. We're trying to look at the more uh how the long-term results of the of investments would affect our clients' overall plan. But if you're in a situation where you have a young family, it might be that getting life insurance in place is by far the on that 20% that will drive 80% of the results from a peace of mind and and structurally having a sound foundation before you build the house. Um we don't spend time with investment uh providers, you know, mutual fund, wholesalers, money managers, life insurance providers. We just don't spend much time with those people unless we have a specific need. Um I don't know if it was still this way when you started in the in the business, but when I did, it was just sort of a natural thing. These wholesalers would call you, and I guess they still call and email, but that that were selling their products to advise through advisors, and you know, you'd I'd have lunch with them because that in some ways that's how you learn, but you realize over time for those of us that can read and do read uh for work that it doesn't give you much bang for your buck compared to doing your own reading. You didn't spend a lot of time with those people that often, did you?

Ben 17:53

Actually, I was gonna ask you if LPL had just um released my info because I've been starting to get more wholesaler calls like in the last five days. I've been getting calls like is LPL selling my info. I don't think that's true, but I'm starting to get more of them. It's funny.

Sean 18:09

It could be because in the year or two since you've been fully licensed, it could be that you're on a different list now. That's as an advisor's. You've always had the CFP, but yeah, so you know, we're sort of just like you get cold calls, probably, or spam emails and calls, we all do, but it's hard because some of these people, you know, they're very knowledge could be very knowledgeable and they're could be fine people, but they're representing their particular product or service, and we are fairly um discriminating on who we spend time with. And so um, even if it's just talking to each other like we are right now, and this is what inspired this sort of this series or this podcast, um, that's usually more productive to throw around ideas than uh listening to someone talk about their newest and greatest ETF when we could get probably 80% of the value or more if we just read their email and the info they sent us.

Ben 19:00

Right. And when you were talking through like the young, young couples, the things that really moved the needle. I was thinking about our meeting yesterday for our client yesterday. An annuity, and we don't recommend annuities for everybody, and we probably do a different type of annuity than you think of whenever you think of annuity, but um an annuity was probably the the thing that was gonna drive the most results for them because they had been nervous in the past, they're nervous sort of now, they realize they need the long-term growth, and so there's a specific type of annuity that will allow them to have long-term growth in the account, and there's um just several benefits that was gonna that were gonna help the client.

Sean 19:40

So yeah, that's a great point. In that particular situation, they've had another one of those since 2011, and they like the the value it's brought, even though as an investment, as an investment only, it hasn't done anything special. But the security and the and the the rock the rock solid income potential has been attractive to them, so they're open to a new and improved version of that. And on the flip side, that tends to be an expensive type of investment, but compared to what, to refer back to one of our previous episodes. Um one of the other things we do focus on uh when we're not using that particular vehicle is investment costs are a big deal, but they're a lot like inflation that's hard to feel in any given, you know, certainly day or even week or year. Maybe recently for a year or two, inflation has been higher, but it's hard to feel it. Uh, the cost, right? But but the investment costs are that are embedded in your investments. Certainly there's a cost to use an advisor, and that hopefully has value for our folks that that we work with. But you always want to make sure you're getting value or you understand the value. But um there's a lot of data that says one of the 20%, the key factors that drive 80% of people's investment results are the underlying costs. And so the a lot of the funds we use are extremely low cost, such such low-cost vehicles that some of them are lower cost than Vanguard, very similar to what Vanguard does, but in some cases lower cost. So the compounding of that is huge, but it's it's unseen, a lot like inflation, therefore it's it's kind of a nasty secret, silent killer of growth.

Ben 21:20

Yeah. Well, and so I guess the the long and the short of it, if we're gonna 80-20 this episode, which I think it's probably good to just wrap it up here because we we kind of think hit all the high points, we're able to help guide our clients to focus on the things that matter and the things that they control. And that's another episode, probably, too. That's a Carl Richards, you know, you've got to focus on things that matter and focus on things that you control and where they intersect. The Venn diagram is what we want to focus on. And so the the 20% of things um again, costs, taxes. A plan that you can stick to, and that could probably be another episode, too. Uh, because not everybody's plan is going to be the same. My workout plan is different than Arnold Schwarzenegger, or you know, it's you just got to come up come up with a plan that you can stick to. So costs, taxes, a plan that you can stick to, kind of an overall uh strategy that makes sense.

Sean 22:25

And one last comment, and then we'll we will wrap it up. Is while some things we might have very strongly held opinions that we wouldn't want to budge from on what goes in that 20% that's most important, a lot of what we do is making sure for the each client we work with, the way they're communicated to, the information they get, uh, how often they get their statement, etc. Uh you get to decide what's in your 20%. And we, of course, we collaborate to decide that. But um, and that's an important part of any relationship with it with a financial advisor is how do you work together? How much control or decision making do you have over the investment philosophy or uh how you communicate, how often you meet, that sort of thing. So a lot of what we do is making sure we understand what makes you tick, what's important to you, what's not, so that we know kind of where your where your 8020 preferences lie so that we can um do our best work for you.

Ben 23:22

Anything else? No, I think that um explains the Pareto principle well, that 80 20 rule that we uh we use in our business, we use for our clients, and so uh I love it. Thanks for your time, man. Enjoyed it. Alrighty, until next time. See ya.