At work, working smart means using your resources and tools to achieve the best possible results in the time you have available. How does this apply to your personal finances?
Many things in life, especially in nature, are set up to achieve the biggest benefit or make the most progress with the least amount of effort. Our ancestors invented the wheel to make moving stuff and people easier, and even in our own homes and offices we are always looking for easier and more efficient ways to get things done.
Often, however, we don’t do the same with our personal finances. Instead of making it as easy as possible to work smart with our money, we often maintain old habits or outdated spending patterns just because we are used to them.
Let’s see if we can change this by applying the 80:20 (or Pareto) principle. The 80:20 principle says that 80% of what happens is caused by 20% of inputs. In the context of personal finance, this means that 80% of your financial success comes from 20% of the actions you take.
Here are five ways to apply the 80:20 principle to managing your money:
- Focus on the big expenses: Identify the 20% of your expenses that make up 80% of your spending. These may include housing, transportation, and food. Look for ways to reduce these expenses by negotiating bills, finding cheaper alternatives, or downsizing if necessary. For instance, if you move closer to your work or your child’s school, the time and money you spend on transport could become significantly less, allowing you to invest that time and money in ways that could benefit your family. If the accommodation options are more expensive, take the time to do a total-cost comparison before you decide.
- Prioritise your debts: Work out which 20% of your debts are causing 80% of your financial stress. Focus on paying off high-interest debts first, such as credit cards or personal loans, to save money on interest and reduce your overall debt burden. Get advice from knowledgeable people about the best solution for you, for instance debt consolidation. It might also be a very good idea to get counselling to help you deal with the mental-health impact of financial worries. When your head is clear and your emotions under control, you are sure to make better financial decisions.
- Simplify your investments: Identify the 20% of investments that are generating 80% of your returns and invest more in them. Instead of chasing individual shares, consider consolidating your investments into low-cost index funds that can provide consistent returns over the long term. Also take the time to learn more about investment principles, such as compound interest (read our blog post about it here) and the importance of keeping investment fees as low as possible. The better informed you are, the better decisions you will make.
- Focus on the 20% of financial tasks that deliver 80% impact. This could include reviewing your budget, tracking your expenses and automating your savings. By simplifying your financial management, you can reduce stress and free up time for other activities. For example, debit orders to automate your savings and bill payments, will keep your savings growing consistently, help you avoid penalties on late payments and keep your credit score healthy.
- Focus on financial decisions that matter most: Some decisions are more important than others for your financial health. For example, choosing the right credit card, negotiating a better interest rate on a loan, or refinancing your mortgage. Pay more attention to the top 20% of decisions and you can have an 80% positive impact on your financial results.