❝The best is the enemy of the good.❞ -Voltaire
The printer is out of ink. Ugh! Now I have to replace it. I wonder how many people knew it was out of ink but let it sit, waiting for me. I pop in the replacement and my article prints. I'm fascinated by an article written by Tim Ferriss, called The Top 5 Reasons to Be a Jack of All Trades. I've often thought that I was pretty good at quite a few things, but the best at nothing. The gossip seems to be that everyone should specialize, though. That's where the money is, they say. Pick something and be the best at it. Not only does that go against my natural curiosity, but it doesn't sit right, but I don't know why.
The article is a bit of confirmation bias, because like everyone else, I want to be able to say, "that's exactly what I've been thinking...only articulated better!" In the article, Tim talks about how the phrase "jack of all trades, master of none" is nonsense. He talks about how people who know a little bit about a lot of things see relationships and the big picture better. Finally, he talks about his wide use of the 80/20 rule.
It gets me wondering about how the 80/20 rule could apply in personal finance.
The Pareto principle, or what I call the 80/20 rule, is the idea that 80% of outcomes come from 20% of the inputs. Some examples are that 80% of a company's productivity comes from 20% of their employees, 80% of language comes from 20% of the words, and 80% of the activities like sports or dance come from 20% of the moves. Effectively, 80% of the effect comes from 20% of the resources.
At the first part of this curve, you get a big bang for your buck. A little bit of effort (20%) gets you a lot of benefit (80%). We would say that this part of the curve is steep.
However, once you surpass the 80% mark, it's very difficult to capture that remaining 20%. The curve is now relatively flat, and thus it takes a lot of effort to get a little bit of benefit. That final 20% takes a lot more time, money, and energy. This is what economists call diminishing returns, or if you are a real nerd, the law of diminishing marginal utility. This is the part of the curve where professional athletes live. They got up to the 80% mark when they were ten years old. For them, it makes a lot of sense to climb the rest of the way up that curve because they are specializing.
For most of us, though, we don't get the same bang for the buck and don't get the benefit that a specialist would. This is actually good, though, because unless we have a specific reason like professional athletes or other specialists do, there's no need to put in the effort to get to the top of that curve. Once we get to the 80% mark, we're free to spend our precious time and energy getting 80% of the way towards our next endeavor.
80/20 IN PERSONAL FINANCE: RULES OF THUMB
In personal finance, we use the 80/20 rule to create rules of thumb. Rules of thumb are rules meant to be general advice that's easy to remember and will get people most of the way to where they need to go.
As we think about rules of thumb for people, it's helpful to think about the bell curve. People, however we organize them, will generally resemble a bell. Most people are in the middle. Most people are average. At the ends are the exceptions; people who have something unique about them.
Since there are more average people than non-average people, by definition, there are more of them. That's what the middle of this bell curve represents.
The bell curve could represent people's financial circumstances, where a particular rule works for average people but not for people who are overly complex. Alternatively, the rule of thumb might not be a good fit for somebody who doesn't have any complexity in their situation and doesn't need any advice or any rule at all.
Rules of thumb work best for people on average.
Just because a particular rule of thumb doesn't apply equally to everybody doesn't mean that there isn't an 80% solution for everyone. Everyone has an 80% solution. It might not be the general rule of thumb that applies to everybody else, but everybody has an 80% solution. The idea is to stop at good enough. Stop the pursuit of perfection. You will never get there, and it's not worth the trouble.
IT ALL DEPENDS
There is no one-size-fits-all advice. One-size-fits-all advice is different from a rule of thumb. For starters, rules of thumb don't work for everybody. Remember, they are less likely to work for people on the ends of the bell curve. One-size-fits-all advice (which doesn't exist in the real world) is advice that supposedly applies to everyone. You can recognize one-size-fits-all advice by how the advice starts.
“You need to...”
“I can't believe you don't...”
These are all pieces of one-size-fits-all advice, and you should not listen to them. The speaker or writer might be confused, talking about a rule of thumb but presenting it as universal advice, but now you'll know the difference.
EXAMPLES OF RULES OF THUMB
Some examples might be helpful for you to think about rules of thumb.
Uses of Debt: One rule of thumb says that it's okay to use debt to pay for appreciating assets but not for depreciating assets. In other words, there is good debt and bad debt. An appreciating asset is simply an asset (something that you own) that will appreciate (go up in value). A depreciating asset is the opposite. It's something that you own that will go down in value.
Therefore, according to this rule of thumb, it's okay to purchase a college education with student loans because the value of that education will be worth more than what you paid for it, and you can sell your time, skills, expertise, and talent for a premium.
Similarly, it's okay to purchase a house with a mortgage. The house is expected to go up in value, at least by inflation and hopefully a little more (note: this applies to owning the house for long periods - house values can go down in the short run).
On the other hand, the rule says you should not buy furniture, electronics, or happy hour drinks with debt.
Since it's a rule of thumb and not a law, nothing here suggests that these tips would work for you. It's entirely possible that paying off a mortgage or buying a house with cash is the best option. It's possible for you to take out too many student loans. And putting purchases on a credit card might be part of a bigger financial plan. That's why it's a rule of thumb and not one-size-fits-all advice.
Buying an appreciating asset can be thought of as investing. Buying a depreciating asset is thought of as an expense. The idea is not to go into debt for expenses.
Maximum Student Loans: This rule of thumb states that you should not take out more in student loans than you expect to make in your first year on the job. This rule helps by saying that if you expect to make $35,000 per year when you get out of college, you should not graduate with more than $35,000 in student loans. If you expect to make $60,000 in your first year then you should not graduate with more than $60,000 in student loan debt.
This little idea helps prevent people from taking out $60,000 in student loans to get a degree in fine arts, where it may be difficult to find a $60,000 per year job. It's unlikely to be a good investment. However, that same $60,000 student loan bill makes sense for an engineering major.
Again, it's not a law. There are people for whom this rule doesn't apply but, that's the brilliance of rules of thumb - they work for most people.
Savings Rate: How much of your income should you save? The rule of thumb on this one isn't clear. Some say it's at least 10%, some say it should be more than 15%. I'll lump savings and investing together and call it 15%. The more automated this is, the easier it will be to do. Pay yourself first and spend the rest.
Always remember to focus on you. What works for others may not work for you, and what works for you may not work for others. Don't put off doing something because it's not perfect or optimized. Start with rules of thumb and adjust them where you need to. You can get most of the way there with a little bit of time and effort. Then you can make it better. Or, you can live your life and let your "good enough" personal finance system run in the background.
You get one life; live intentionally.
If you know someone else who would benefit from reading this, please share it with them. Spread the word, if you think there's a word to spread.
Related Money Health® Reading
References and Influences
Ariely, Dan & Jeff Kreisler: Dollars and Sense
Clear, James: Atomic Habits
Dunn, Elizabeth & Michael Norton: Happy Money
Ferriss, Tim: The Top 5 Reasons to Be a Jack of All Trades
Fogg, B.J.: Tiny Habits
Klontz, Brad & Ted Klontz: Mind Over Money
Manson, Mark: The Subtle Art of Not Giving a Fuck
McKeown, Greg: Essentialism
Millburn, Joshua Fields & Ryan Nicodemus: Essential
Note: Above is a list of references that I intentionally looked at while writing this post. It is not meant to be a definitive list of everything that influenced by thinking and writing. It's very likely that I left something out. If you notice something that you think I left out, please let me know; I will be happy to update the list.