What Is the Pareto Principle—aka the Pareto Rule or 80/20 ...

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The Pareto Principle states that 80% of consequences come from 20% of the causes. · The principle, which was derived from the imbalance of land ownership in ... Economy Economics Investopedia/MiraNorian WhatIstheParetoPrinciple? TheParetoPrinciple,namedaftereconomistVilfredoPareto,specifiesthat80%ofconsequencescomefrom20%ofthecauses,assertinganunequalrelationshipbetweeninputsandoutputs.Thisprincipleservesasageneralreminderthattherelationshipbetweeninputsandoutputsisnotbalanced.TheParetoPrincipleisalsoknownastheParetoRuleorthe80/20Rule. KeyTakeaways TheParetoPrinciplestatesthat80%ofconsequencescomefrom20%ofthecauses.Theprinciple,whichwasderivedfromtheimbalanceoflandownershipinItaly,iscommonlyusedtoillustratethenotionthatnotthingsareequal,andtheminorityownsthemajority.Unlikeotherprinciples,theParetoPrincipleismerelyanobservation,notlaw.Althoughbroadlyapplied,itdoesnotapplytoeveryscenario. 2:23 TheParetoPrinciple(80-20Rule) UnderstandingtheParetoPrinciple TheoriginalobservationoftheParetoPrinciplewaslinkedtotherelationshipbetweenwealthandpopulation.AccordingtowhatParetoobserved,80%ofthelandinItalywasownedby20%ofthepopulation.Aftersurveyinganumberofothercountries,hefoundthesameappliedabroad.Forthemostpart,theParetoPrincipleisanobservationthatthingsinlifearenotalwaysdistributedevenly. TheParetoPrinciplecanbeappliedinawiderangeofareassuchasmanufacturing,management,andhumanresources.Forinstance,theeffortsof20%ofacorporation'sstaffcoulddrive80%ofthefirm'sprofits.TheParetoPrinciplecanbeappliedespeciallythosebusinessesthatareclient-servicebased.Ithasbeenadoptedbyavarietyofcoachingandcustomerrelationshipmanagement(CRM)softwareprograms. Itcanalsobeappliedonapersonallevel.TimemanagementisthemostcommonusefortheParetoPrinciple,asmostpeopletendtothinlyspreadouttheirtimeinsteadoffocusingonthemostimportanttasks.Intermsofpersonaltimemanagement,80%ofyourwork-relatedoutputcouldcomefromonly20%ofyourtimeatwork. ExampleoftheParetoPrinciple FinancialadvisorybusinessescommonlyusetheParetoPrincipletohelpmanagetheirclients.Thebusinessisdependentontheadvisor’sabilitytoprovideexcellentcustomerservice,asitsfeesrelyonitscustomers’satisfaction.However,noteveryclientprovidesthesameamountofincometotheadvisor.Ifanadvisorypracticehas100clients,accordingtotheParetoPrinciple,80percentofthefinancialadvisor’srevenueshouldcomefromthetop20clients.These20clientshavethehighestamountofassetsandthehighestfeescharged. Important AdvisorypracticesthathaveadoptedtheParetoPrinciplehaveseenimprovementintimemanagement,productivity,andoverallclientsatisfaction. TheParetoPrincipleseemssimplebutishardtoimplementforthetypicalfinancialadvisor.Theprinciplesuggeststhatsince20clientsarepaying80percentofthetotalfees,theyshouldreceiveatleast80%ofthecustomerservice.Advisorsshould,therefore,spendmostoftheirtimecultivatingtherelationshipsoftheirtop20clients. However,ashumannaturesuggests,thisdoesnothappen.Mostadvisorstendtospreadouttheirtimeandserviceswithlessregardtoaclient’sstatus.Ifaclientcallsandhasanissue,theadvisordealsaccordingly,regardlessofhowmuchincometheclientactuallybringsintotheadvisor. Theprinciplehasalsoledtoadvisorsfocusingonreplicatingtheirtop20%ofclients,knowingthataddingaclientofthatsizeimmediatelyaffectsthebottomline. AdvantagesoftheParetoPrinciple ThereisapracticalreasonforapplyingtheParetoPrinciple.Simply,itcangiveyouawindowintowhotorewardorwhattofix.Forexample,if20%ofthedesignflawsinacarareleadingto80%ofthecrashes,youcanidentifyandfixthoseflaws.Similarly,if20%ofyourcustomersaredriving80%ofyoursales,youmaywanttofocusonthosecustomersandrewardthemfortheirloyalty.Inthissense,theParetoPrinciplebecomesaguideforhowtoallocateresourcesefficiently. DisadvantagesoftheParetoPrinciple Whilethe80/20splitistrueforPareto'sobservation,thatdoesn'tnecessarilymeanthatitisalwaystrue.Forinstance,30%oftheworkforce(or30outof100workers)mayonlycomplete60%oftheoutput.Theremainingworkersmaynotbeasproductiveormayjustbeslackingoffonthejob.ThisfurtherreiteratesthattheParetoPrincipleismerelyanobservationandnotnecessarilyalaw. ArticleSources Investopediarequireswriterstouseprimarysourcestosupporttheirwork.Theseincludewhitepapers,governmentdata,originalreporting,andinterviewswithindustryexperts.Wealsoreferenceoriginalresearchfromotherreputablepublisherswhereappropriate.Youcanlearnmoreaboutthestandardswefollowinproducingaccurate,unbiasedcontentinour editorialpolicy. ColoradoDepartmentofTransportation."ParetoAnalysis." CompareAccounts AdvertiserDisclosure × TheoffersthatappearinthistablearefrompartnershipsfromwhichInvestopediareceivescompensation.Thiscompensationmayimpacthowandwherelistingsappear.Investopediadoesnotincludealloffersavailableinthemarketplace. Provider Name Description RelatedTerms The80-20Rule(akaParetoPrinciple):WhatItIs,HowItWorks The80-20rule,alsoknownastheParetoPrinciple,usedmostlyinbusinessandeconomics,statesthat80%ofoutcomesresultsfrom20%ofcauses. more WhatIsParetoAnalysis?HowtoCreateaParetoChartandExample Paretoanalysisstatesthat80%ofaproject'sresultsaredueto20%ofthework,orconversely,80%ofproblemscanbetracedto20%ofthecauses. more WhatIsTotalQualityManagement(TQM),andWhyIsItImportant? Totalqualitymanagement(TQM)aimstoholdallpartiesinvolvedintheproductionprocessasaccountablefortheoverallqualityofthefinalproductorservice. more WhatDoesCeterisParibusMeaninEconomics? Ceterisparibus,aLatinphrasemeaning"allelsebeingequal,"helpsisolatemultipleindependentvariablesaffectingadependentvariable. more WelfareEconomicsExplained:Theory,Assumptions,andCriticism Welfareeconomicsfocusesonfindingtheoptimalallocationofeconomicresources,goods,andincometobestimprovetheoverallgoodofsociety. more Robo-AdvisorDefinition Arobo-advisorisatypeofautomatedfinancialadvisorthatprovidesalgorithm-drivenwealthmanagementserviceswithlittletonohumanintervention.Here’showitworks. more PartnerLinks RelatedArticles PortfolioManagement HowtoPickYourInvestments AutomatedInvesting Robo-Advisor:AdvantagesandDisadvantages AutomatedInvesting BestRobo-Advisorsof2022 PracticeManagement TheBenefitsofFee-BasedandFee-OnlyAdvisoryModels Economics Real-LifeExamplesofthe80-20Rule(ParetoPrinciple)inPractice AutomatedInvesting Wealthfrontvs.VanguardPersonalAdvisorServices:WhichIsBestforYou?

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