The Pareto Principle is one of the most popular economic ideas of all time. Also known as the “80/20 rule,” this principle arose from Vilfredo Pareto realizing that 80% of the land in Italy was owned by 20% of the people (in 1896). Richard Koch further broke down the 80/20 rule in his famous book The 80/20 Principle. Here he advised businesses to focus on the 20% of their customers that purchase 80% of their goods and services. Since both of these great minds submitted their commentary, this rule has been applied to a plethora of other areas. Today, we will be discussing how to apply it to your retirement. So, how will it help you retire sooner?
One of the prevailing principles of saving nowadays is the Babylonian technique. This one requires the user to save 10% of everything they make, and it is truly a valuable discipline to take on. With that said, I think we can do better. In the spirit of “80/20,” we are going to go ahead and double the Babylonian principle. Budget with 80% of what you make, and save the other 20. If you’re saving twice as fast, you can retire twice as quickly. In addition, interest you are able to make with the extra money will compound year-over-year, and can speed this up even moreso if you invest wisely.
Holiday bonus season has passed, and tax refund season follows behind it. All of this cash fills us with dreams of what big purchase we are going to make with these “extras.” While I’m not going to say you don’t deserve to have some fun with your bonuses, I can say that it acts against the singular focus of an early retirement. So, if retiring early is your goal, spend 20% of that bonus and tuck the rest away. This sort of reverses the saving application of your regular income, but that is because this income is in addition to your regular paycheck. If you’ve budgeted well, you should be comfortable whether or not you ever receive your bonus or tax refund. If you can survive with 0% of it, then only using 20% is still a bonus!
When you are utilizing the 80/20 rule in your retirement savings, make sure you are taking advantage of your 401k employer match. Most employers will match a certain amount of money each year that you choose to contribute toward a 401k. Never turn away free money. Out of your 20% savings, make sure you are contributing the maximum that your employer will match so that you consistently optimize your retirement fund. Don’t use the 80/20 rule to be lazy and complacent with your savings, make sure you are always strategizing with your money to make sure you benefit as much as possible.