# The Pareto Principle—aka the Pareto Rule or 80/20 Rule

> **Definition**
>
> The Pareto Principle states that a small portion of inputs generates the majority of consequences.

## What Is the Pareto Principle?

The Pareto Principle is an observation that 80% of consequences come from 20% of the causes, indicating that inputs and outputs have an unequal relationship.

The principle originated as a conclusion about the unequal distribution of [wealth](https://www.investopedia.com/terms/w/wealth.asp). It was later applied to business management as a way to measure the effectiveness of resource distribution and adjust resource allocation based on results.

### Key Takeaways

*   The Pareto Principle states that 80% of consequences come from 20% of the causes.
*   It originates in an observation about the unequal distribution of weaIth.
*   The principle has been adapted to improve productivity in manufacturing and people management by allocating resources more efficiently.

![Pareto Principle](https://www.investopedia.com/thmb/KvtGdMC9oFglwQVjK3KQXGgxsq4=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/TermDefinitions_Paretoprinciple-42d314180f794822b1b799724c2fc70d.jpg)

*Under this principle, 80% of effects come from 20% of causes, although the exact ratio may vary. — Mira Norian / Investopedia*

## Understanding the Pareto Principle

The theory underlying the Pareto Principle was developed by Vilfredo Pareto, an economist and sociologist with a particular interest in wealth distribution, in 1906. It was named the Pareto Principle by management consultant Joseph M. Juran in the 1940s.

Pareto observed that the majority of Italy’s land wealth (80%) was owned by a minority (20%) of its people. After surveying other countries, he found the same applied abroad. For the most part, the Pareto Principle is an observation that things in life are not always distributed evenly.

The Pareto Principle can be applied in a wide range of undertakings, including [manufacturing](https://www.investopedia.com/terms/m/manufacturing.asp), management, and [human resources](https://www.investopedia.com/terms/h/humanresources.asp).

It suggests, for example, that the efforts of 20% of a corporation’s staff might drive 80% of the firm’s [profits](https://www.investopedia.com/terms/p/profit.asp).

The Pareto Principle is even more applicable to businesses that are client-service based. It has been adopted by a variety of coaching and [customer relationship management (CRM)](https://www.investopedia.com/terms/c/customer_relation_management.asp) software programs.

It can also be applied on a personal level. Time management is the most common use of the Pareto Principle. The assertion is that most people with many tasks spread their time among them instead of focusing on the most important tasks. In terms of personal time management, 80% of their work-related output comes from only 20% of their time at work.  

## Special Considerations

The Pareto Principle seems simple but is hard to implement for the typical [financial advisor](https://www.investopedia.com/terms/f/financial-advisor.asp). The principle suggests that since 20 clients are paying 80% of the total fees, they should receive at least 80% of the customer service. Advisors should, therefore, spend most of their time cultivating the relationships of their top 20 clients.

However, as human nature suggests, this does not always happen. Most advisors tend to spread out their time and services with less regard for a client’s status. If a client calls and has an issue, the advisor deals accordingly, regardless of how much income the client brings to the advisor.  

## Advantages and Disadvantages of the Pareto Principle

### Advantages

There are practical ways to apply the Pareto Principle. It can focus a business’s attention on its most urgent priorities.

For example, if a car manufacturer’s managers find that 20% of the design flaws in one of its models are contributing to 80% of the crashes it is involved in, managers can direct their engineers to focus their attention on those flaws.

Similarly, if a business finds that 20% of its customers drive 80% of its sales, it may want to focus on those customers and reward them for their loyalty.

In this sense, the Pareto Principle becomes a guide for how to allocate resources efficiently.

### Disadvantages

While the [80/20 split](https://www.investopedia.com/terms/1/80-20-rule.asp) is true for Pareto’s observation, it’s not necessarily always true. It is based on anecdotal evidence rather than scientific analysis.

For instance, 20% of a workforce may complete 60% of a company’s output. The remaining workers may be slacking off, poorly motivated, or assigned to the wrong tasks. More analysis would be needed before taking action.

The Pareto Principle is merely an observation and not necessarily a law.

The principle has led some financial advisory firms to direct too much of their attention to the top 20% of their clients while neglecting the rest.

Pros

*   Identifies an organization’s most efficient processes and people
    
*   Indicates areas that need more attention (or less)
    

Cons

*   Based on anecdotal evidence rather than scientific analysis
    
*   Observation must be further analyzed before effective action can be taken
    

## Example of the Pareto Principle

Financial advisory businesses commonly use the Pareto Principle to help manage their clients. The business depends on the advisor’s ability to provide excellent [customer service](https://www.investopedia.com/terms/c/customer-service.asp), as its fees rely on its customers’ satisfaction.

However, not every client provides the same amount of income to the advisor. If an advisory practice has 100 clients, according to the Pareto Principle, 80% of the financial advisor’s [revenue](https://www.investopedia.com/terms/r/revenue.asp) should come from the top 20 clients. These 20 clients have the highest amount of [assets](https://www.investopedia.com/terms/a/asset.asp) and the highest [fees](https://www.investopedia.com/terms/f/fee.asp) charged.

## How Does the Pareto Principle Work?

The Pareto Principle is a concept that suggests that 80% of the end results of an action are due to 20% of causes. In business and finance, the principle is used to determine which inputs are the most profitable and productive. This allows the observer to adjust priorities and processes for greater efficiency.

## Does the Pareto Principle Always Work?

The Pareto Principle or 80/20 Rule is generally considered to be valid and useful, but it is not considered to be a method of scientific analysis.

As such, the principle can help a business or an individual consider priorities and focus resources more efficiently.

## How Can I Use the 80/20 Rule to Invest My Money?

When it comes to your investments, the Pareto Principle can be used to help you choose the [right balance of risk and reward](https://www.investopedia.com/terms/r/riskrewardratio.asp) in your portfolio. You’ll want to focus your attention on the 20% of your [portfolio](https://www.investopedia.com/terms/p/portfolio.asp) that is giving you 80% of your [returns](https://www.investopedia.com/terms/r/return.asp).

For instance, if you are relatively [risk averse](https://www.investopedia.com/terms/r/riskaverse.asp), you may want to invest 80% of your portfolio in safe assets and 20% in riskier classes.

## The Bottom Line

Companies may apply the Pareto Principle when evaluating which strategies are working and where improvements can be made. Investors can use it to help them focus on their key investment goals.

Keep in mind that there is no scientific evidence that backs up the principle. It is a way to evaluate results, reconsider priorities, or identify weaknesses.

> **Article Sources**
>
> 1.  Britannica Money. “[Vilfredo Pareto](https://www.britannica.com/money/Vilfredo-Pareto).”
>     
> 2.  Oregon Women Lawyers. “[Understanding Pareto’s Principle—The 80-20 Rule](https://oregonwomenlawyers.org/wp-content/uploads/2018/05/The-80-20-Rule-Paretos-Principle-copy.pdf).”