I’m going to make a pretty bold claim here — Vilfredo Pareto may well be the most influential man that you’ve never heard of.
Mm-hm. That’s right. Already, I can picture you raising your eyebrows in confusion. You might even have trouble pronouncing his name. It’s a bit of a tongue-twister, isn’t it?
But don’t sweat it. I’ll bring you up to speed.
The birth of a genius…
Vilfredo Pareto was an Italian scholar born in 1848. It was a dramatic year. Europe was in the grip of a revolutionary fever, and from France to Germany to Poland, people were rebelling against feudalism and royalty. In fact, this was the very year when Karl Marx published his landmark book, Manifesto of the Communist Party.
It was against this turbulent backdrop that Vilfredo Pareto came of age. At a time when most folks were working class, toiling up to 15 hours a day to make a living, Pareto had the good fortune to be born into an aristocratic family. They weren’t terribly wealthy, but they were comfortably middle class. Lucky guy.
This allowed him to blossom into something of a Renaissance man. And he dabbled in a wide range of subjects — engineering, politics, philosophy. But his greatest claim to fame lay in what he did in the realm of economics.
You see, in 1906, Pareto did the sums, and he noticed that 80% of the land in his native Italy was owned by 20% of the population. This intrigued him greatly. This led him to do even more research. His next stop? His home garden. And, hey presto, he noticed that 80% of the peas came from 20% of the peapods. A direct correlation.
His discovery became known as the Pareto Principle. Or, to use a more catchy term, the 80/20 Rule. Pareto’s academic observation was all about the distribution of wealth — a pattern which he believed was present in any human society, in any era, in any country.
Yep, it was a pretty tall claim. But Pareto’s research was good as gold, and it held up to scrutiny. And like most great ideas, it wasn’t too long before the 80/20 Rule found a very useful application in the modern world.
How the 80/20 Rule created an economic miracle…
This happened in 1954 when a Romanian-American engineer named Joseph Juran travelled to Japan to solve a very serious problem.
You see, Japan, at the time, was struggling to emerge from the devastation of the Second World War. The country really wanted to reinvent itself as an industrial power. That meant manufacturing consumer goods that could be exported overseas in return for hard cash. You could say that it was matter of national survival, not to mention cultural honour.
Unfortunately, ‘Made in Japan’ had gained a negative reputation. Their products were riddled with defects. They would break, and they would break a lot. It was a national embarrassment for the Japanese, and industrial morale was at an all-time low.
That’s where Joseph Juran came in. He was an expert in quality management, and he happened to be a huge fan of Vilfredo Pareto’s 80/20 Rule. So he used the theory to teach Japanese companies a fresh approach — 80% of the problems they were facing were actually caused by 20% of issues.
Well — gasp — could the solution really be that simple?
Uh, apparently, it was!
With this new focus in mind, the Japanese feverishly developed a process to identify and eliminate the most pressing product defects. And slowly, surely, the Japanese mastered the art of rolling out sleek, shiny products on the assembly line with minimal errors.
It’s astonishing when you think about it. The Japanese economic miracle was the result of an American management guru, who was actually inspired by an Italian economist. [openx slug=inpost]
The 80/20 Rule in the 21st century…
The proof is in the pudding, as they say. And Japan’s success with the 80/20 Rule meant that this approach was soon applied in a wide range of contexts.
In fact, you can see the 80/20 Rule happening right now in the present day.
Here is some fascinating trivia:
- 80% of healthcare resources are used by 20% of patients
- 80% of sporting medals are won by 20% of athletes
- 80% of injuries and accidents are caused by 20% of health hazards
- 80% of software glitches are caused by 20% of bugs
- 80% of retail complaints come from 20% of shoppers
- 80% of our domestic arguments come from 20% of our differences
- We wear 20% of our clothing 80% of the time
- 20% of your carpet receives 80% of the wear
- 20% of your exercise routine produces 80% of the results
And on and on it goes…
Now, as an investor, chances are, you’re always searching for that silver bullet. That magic formula. That way to make your money work harder so that you can see a better return on your investment.
And, if you think about it, the 80/20 Rule may well apply to your situation as well. 20% of the stocks in your portfolio may be responsible for 80% of your gains. On the other hand, 80% of your losses may come from 20% of your holdings.
We now live in an age where we’re spoilt for choice — we are seeing everything from cryptocurrencies to cannabis start-ups. The tech revolution has unleashed a tidal wave of opportunities on the horizon.
Yet the eternal questions for any investor remains the same:
- What to buy?
- What to hold?
- What to sell?
Here at Money Morning New Zealand, we are determined to get some answers. We will study the financial landscape, outline the threats, and chart a path forward for you to take. So that you can make an informed decision and create your own custom 80/20 portfolio…
In the eternal words of Vilfredo Pareto, it’s all about separating ‘the vital few from the trivial many.’
Contributor, Money Morning New Zealand