The 80/20 Principle of Personal Finance

I’d heard of the Pareto Principle, or the 80/20 rule, before I’d read the book. Actually, I was painfully familiar with the other side of it undergrad, where I frequently reminded myself that the last 20% in a class takes as much energy to earn is as the first 80%. Now I want to share how the 80/20 rule can be applied to your finances.

80% of your financial results will come from 20% of your money management

If you don’t believe me, think about it: the bulk of your future riches will come from implementing very simple habits now. You will reap a far greater return on setting up an automatic savings plan than the time it takes you to do so. Likewise, think about the return of paying off your student loans in 2 years instead of 10. Ultimately, there are some money-management tasks that matter way more than others. So while it’s good to cut coupons for groceries, it’s more important to nail the big-picture items than strive for the details.

The 20% of your money management that will result in 80% of your financial results are as follows

Save for retirement in your 20’s

The earlier and more money you put away, the better, but ultimately the habit of saving matters most. It’s easy to save if it’s something you’re used to doing, it’s getting started that’s the hard part.

Get out and stay out of debt

Sometimes debt is necessary to invest in a future income-generating asset, such as university education. This is the only debt you should ever incur, and when you have it, you should be on a mission to get rid of it quickly.

Start early and profitably in your career

I’m a big advocate of avoiding dead-end and low paying jobs if you can. If you can’t, it’s best to work any job you can and continue building your skill set while you look for something more. But before the job hunt even begins, one of the most important things is finishing your university degree quickly and cheaply. Every student that drags out a 4-year bachelor’s degree into a 5 or 6-year show is not only paying one more year of tuition, but they’re also missing out on another year of income in a professional job. In other words, another year of school isn’t costing you $6,000, it’s costing you over $40,0000.

Be financially literate

Until I started my MBA, all my financial knowledge was self-taught. If that sounds daunting, it’s not. Money is actually very straight-forward once you get into it (there are a lot of excellent books), and the more you know, the less you’ll be intimidated by going forward.

Taking time to understand things like fees charged on your mutual funds or whether an RRSP or TFSA is better for you tax-wise takes some research, but the payoff is huge. Remember, you only need to learn something once. Once you’ve got an understanding of a financial concept, the payoff of that is for life.

Track your spending

We all hate to do it, but even I eventually succumbed to keeping track of where every penny I spend is going. Consequently, I know where I’m over-spending, where I have some wiggle-room, and what I need to cut out entirely. If you’re spending $3,000 a year on restaurants, that’s your prerogative, but doing so without being aware of it isn’t forgivable. What gets measured, gets managed, and if you measure your spending, you’ll manage it properly.

What about the other 80%?

The other 80% of money management that will only affect 20% of your financial results is a large amount of small things. Namely, how you manage your money day to day on necessary costs like rent and food. No matter how much people harp on the latte factor, it’s not going to bankrupt you. If you adhere to the five 20% points I listed above, you’ll be financially secure even if you have a bad caffeine habit or a penchant for expensive vacations.