How to use the 80/20 Principle as an investor (or do what matters)

Recently I read “The 80/20 Principle” by Richard Koch. While I’ve been aware of the concept for a while, delving into the book helped clarify some thinking around investing approach. What’s the main premise of the book and what were the key lessons as an investor?

The big idea

In a nutshell, this says that 80% of your results come from 20% of your effort. Whether that be advertising, performance on the job (it’s helping me here too), exercise, or growing your personal wealth (and moving towards financial independence).

For example, while income from a job is relatively predictable and can increase over time, by itself this will probably not make you financially free. After all, assuming you could save $20,000 per year from your salary, it would take 50 years to save $1 million (assuming no growth and ignoring inflation for now).

Yet apply a little compounding at the long-run rate for S&P 500 of 9%, your $20,000 annual contribution grows to $1 million within 18 years. Even accounting for inflation adjusted returns of 7% per annum compounded, it still takes just 20 years vs 50 years.

While some folks do very well in jobs long-term (think doctors, dentists, lawyers; company executives with stock options), these pale in comparison when comparing the power of even modest income, modestly compounded.

Thus, 80% of your financial freedom will likely come from the power of compounding, applied in a 20% way (the skew of percentages could of course be even higher).

80/20 applied to investing

As described above, 80/20 is very powerful just using an indexing approach alone. For most people who don’t have the time or inclination to be active investors, this is the best way to go.

If however, you’re an active investor and willing to put in the time and effort, how can you apply the 80/20 principle?

Figure out what it is you do well and enjoy doing. Find your investment niche. For me this involves sitting quietly in a room, reading, thinking, writing, and letting ideas and concepts develop in my head. It requires time to assimilate information and to process these into investable ideas.

It can be painstaking work since you may go a while without any special insight. Then all of a sudden, because of the prep work you’ve already done, something comes together and you act.

Thankfully, the mental processing part of the work can take place anytime or anywhere – usually when I’m relaxing or doing something unrelated to investing. Walking helps. The 80/20 approach is also particularly useful for me since I have to fit investing in around a full-time job and family commitments (most of the work is done evenings and weekends).

For others who adopt a more people based investing approach, it could be networking with CEOs and industry executives of companies within sectors of interest. They may glean their insights from a scuttlebutt approach, or gauging people’s responses, reading verbal and non-verbal cues.

Some may adopt a mostly quantitative approach, where the focus is on building and testing software models and algorithms. The specifics of one approach versus another matter less. What matters is going deep into the one that works for you.

Avoiding the distractions

By applying the 80/20 principle to your investing, first figure out what activities generate return and what is wasted time. For me, I realized that writing this blog is very helpful: writing forces clarity of thought; re-reading posts over time serve as a useful reminder to what I’ve learned; and, it leads to connection with other value investors where we learn from each other. For that and more, thank-you dear readers for your time and support.

However, time I have spent thinking and researching peripheral issues like blogging and monetization strategy, list-building, aesthetics – I’ve found is largely NOT a productive use of my investing time. But don’t get me wrong – it’s very easy to fall into a “strategy” black hole and waste hours before hauling yourself out.

Hence, I remind myself often of the somewhat uncommon business model for this blog.

The 80/20 bottom line

Filtering all of the above, what two things are most effective for my approach to investing?

  • Read company filings – especially 10-Ks
  • Read the Wall Street Journal and other quality financial press

If I can do these every day, they will be valuable small steps to get closer to investing goals. As with Warren Buffett’s biggest secret, it’s all about focus.

Spend some time thinking about how you could use the 80/20 principle for investing. What’s your bottom line?

By Raman Minhas