Applying The 80/20 Rule To Your Finances
Ever heard of the 80/20 rule? It suggests 80% of an outcome is often the result of just 20% of the effort you put into it.
It’s often worth going the extra mile. But sometimes, you can get more with less effort by prioritizing the 20% of your efforts that make the biggest splash.
In that spirit, here are a few financial best practices that pack a lot of value per “pound.”
Investing: 80% Of Success Is Showing Up
You could do far worse than to invest according to a sentiment attributed to filmmaker Woody Allen:
“80% of success is showing up.”
Going back to 1926 and after adjusting for inflation, U.S. stocks have delivered about 7.3% annualized returns to investors who have simply been there, earning what the markets have to offer over the long haul.
Those who instead fixate on dodging in and out of hot and cold markets are expected to reduce, rather than improve their end returns. That’s because, when markets recover from a downturn, they often more than make up for the stumble quickly, dramatically, and without warning (see one of our favorite charts on this topic, here).
Asset allocation - a name for investing in appropriate percentages of security types (e.g., stock versus bonds), or asset classes (e.g., large stocks versus small stocks) based on their risk/return “personality” - takes the 80/20 rule to the extreme: Both practical and academic analyses have found that asset allocation is responsible for almost all of the return (94%) across and among different portfolios. The remainder is attributable to individual security selection (4%) and market timing (2%).1
However, even though security selection and market timing explained just 6% of the variability of returns, their overall contribution to performance was negative.
The average portfolio lost -1.03% from market timing decisions and security selection decisions.1
So, to build an efficient portfolio, we suggest paying the most attention to your overall asset allocation, rather than focusing on a few particular securities. And once you’ve got a personalized, tax-aware asset allocation in place, the only reason to change it is if you change. If you’re tempted to alter your allocations based on current market conditions, circle back to our first point.
Financial Planning: Write Down Your "Why"
Also in 80/20 rule fashion, an ounce of financial planning can alleviate pounds of doubt.
"Financial planning isn't just about investing; it's about what money can do for your confidence, security, and quality of life."2 It connects your resources with your values and priorities. The resulting outcome guides "why" you’re taking action. It’s can be a gentle reminder and your touchstone if uncertainty ever eats away at your resolve.
Your "why" doesn't need not be elaborate or time-consuming to be effective. In The One-Page Financial Plan, author Carl Richards describes:
“Your one-page plan simply represents [a few] things that are the most important to you: some action items that need to get done along with a reminder of why you’re doing them.”
If you’d like to add more, great! So do we. Roth accounts, new legislation, tax planning, donor-advised funds, etc., are all part of the other 80% that we hope to consider each day with (and for) clients. But even a one-line "why" will give you a huge head start. Write it down, as Richards describes. When in doubt, read what you’ve written. Is it still “you”? If so, your work is done; stick to plan. If not, consider what’s changed, and update your plan accordingly. It can be that easy.
Data Security: Freeze Your Credit Reports
Even the best-laid financial plans can be thwarted if your assets are exposed to financial scams and identity theft slams. Fortunately, there’s a lot you can do to secure your financial data. We’ve written a handy quick-reference guide on that here: Protecting Your Identity & Private Information.
If we were to pick one practical, but often overlooked punch that delivers among the biggest blows to identity theft, it’s the ability to freeze your credit reports.
Freezing each of your accounts with the three major credit bureaus (Equifax, Experian, and TransUnion) is like locking the doors to your home or vehicle.
It creates a few extra steps for you, and you’ll need to temporarily lift the freeze if you wish to take out a loan or when you apply for Social Security. But it costs nothing to set up and manage. And if an identity thief does get ahold of your information, it should stop them cold if they try taking out lines of credit in your name. This strikes us as an 80/20 trade-off well worth making.
Building Lifetime Wealth, 80/20 Style
Properly applied, the 80/20 rule can help minimize the time and energy you have to put into maximizing your financial well-being.
Whether you’re saving for retirement, funding your kids’ college education, preparing for a wealth transfer, applying for insurance, or otherwise managing your hard-earned wealth, we can help you identify and execute these and other actions that matter the most, so you can get back to the rest of your life.
Want to learn more? Give us a call today. Consider it part of the 20% of your efforts that should take you far.
Footnotes
[1] Gary P. Brinson, L. Randolph Hood and Gilbert L. Beebower, “Determinants of Portfolio Performance,” Financial Analysts Journal, July/August 1986.