❝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.