Two Ways to Save (and Make) More Money in Less Time, Using Principles of Economics

06/23/2012
By
Finance

Finance (Photo credit: Tax Credits)

Economics is arguably the most boring subject on earth. I used to set an alarm clock whenever I had to read my textbooks. My wife (then fiancé) refused to proofread my economics term papers except right before bed. Many nights of insomnia have been cured thanks to my copy of Adam Smith’s Wealth of Nations. Pareto’s 80/20 rule might be economics (and boring by association), but it will help your family’s finances.

What is the 80/20 Rule?

80 percent of the results come from 20 percent of the causes. Yes, that’s English you are reading and once it makes sense, it’ll improve your financial decision making.

Vilfredo Pareto was an economist who was obsessed with optimization. He wanted to know optimal allocations of wealth and utility. His explorations of wealth distribution lead him to the discovery that roughly 80 percent of a nation’s wealth was controlled by 20 percent of the population.  Over time, businessmen latched on to the research and expanded the principle to optimizing management.

Often, 20 percent of your financial obligations rule 80 percent of your financial resources. For example, you probably spend 80 percent of your time talking on the phone to 20 percent of the people that you’ve called. 80 percent of your capital gain probably came from 20 percent of the stock you invest in.

JP’s Principle

Pareto’s 80/20 rule has many uses in personal finance as well. Many authors and bloggers have put it to good use. However, they often only use half of the power of the 80/20 rule. Here is the part that they get right.

You should use the 80/20 rule to identify the 20 percent of things impacting the 80 percent of your finances. Focus on these things and you’ll maximize financial impact.

However, I find this a narrow application of the rule. Personal finance and family finance are all about managing two essential ingredients: money and time. Most people understand how the rule applies to money, but often at the expense of time.

Here’s an illustration.

The average family spends 63% of their expenses on just three spending categories: housing, transportation and food. The 80/20 rule would indicate that finding ways to cut these three categories will have the greatest savings to your family’s finances. However, not all ways are created equal.

Many people have focused on their food budget by extreme couponing. For some couponers, they can eradicate almost all food spending with 10 hours of couponing each week. Since the food budget is item number three in the list of big ticket family expenses, the effort is justified by most people’s interpretation of the 80/20 rule. However, the average family food expense is about $350 per month; at 40 hours of work each month, extreme couponers are couponing at $8.75 per hour. That’s just about minimum wage.

JP’s Principle attempts to add time to the equation.

JP’s Principle is: spend an hour saving $30 and 5 minutes saving $2.50. Or in other words, spend 20 percent of your time for 80 percent of financial impact.

If you are going to invest large amounts of time, make sure that there is a major impact to your finances. However, don’t ignore low-hanging fruit either.

Examples of JP’s Principle in Action

Two years ago, I wanted to lower my family’s food budget from $650 to $350 per month. I meticulously tracked our meals and food spending for a month and found that we ate a lot of high cost meals. It probably took about 8 hours of boring recordkeeping. However, we set a goal of $1 per serving for every meal and ever since then, we’ve cut our budget by $300 per month.

It took a lot of time and effort, but the payoff has meant $3,600 in savings every year.

For years, I’ve done direct deposit from my employer into a checking account. I earn $0 interest for the 30 days the money sits in that account before I pay my bills. I spent 5 minutes changing my direct deposit to a savings account instead. It’s only a little bit of interest; $3 per month to be exact. However, I now earn $36 per year for five minutes of work. If I come up with 10 of these ideas this year, I’ll have given myself a 1% raise in salary.

It’s not a lot of effort, but it took almost no time to setup. It’s not extremely helpful alone, but if it’s the first of many such time investments, it’ll add up to a much larger impact on your finances.

JP’s Principle Simplified into Two Golden Rules

I know many of you like things boiled down into simple rules, so here is JP’s Golden Rules based on JP’s Principle. If you want to get more money out of your budget and improve your financial decision making:

  1. Find and pick low-hanging fruit. Low-hanging fruit is anything that creates value or saves money for very little time. Hopefully, only a one time effort or infrequent effort, like once a month.
  2. Focus on cutting your three biggest bills or finding three big ways to make money. These items might take up a lot of time, but the time is worth it because the payoff is big.

My hope is to start a Tuesday series where I’ll share ideas that are low hanging fruit, some of the big dollar successes my family has found and some popular efforts people make that don’t really have large economic payoffs.  I hope that they might help you to improve your own finances, but most importantly, to at least get you thinking about save/making money and also saving/spending time.

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11 Responses to Two Ways to Save (and Make) More Money in Less Time, Using Principles of Economics

  1. Kurt @ Money Counselor on 06/23/2012 at 2:03 pm

    This really makes a lot of sense! Unfortunately, applying this logic to the payback I get on the time spent on my blog, I’ve concluded I should terminate the blog! :-) Guess I get more out of than cash…

    Looking forward to the low hanging fruit series so I can make/save money with little time spent.

    • John on 06/24/2012 at 9:02 pm

      Yeah. I’ve made some money writing online and blogging, but when you really figure in all the hours I’ve spent blogging, I’m sure I’d need to earn tens of thousands to break even.

  2. Squirrelers on 06/24/2012 at 5:16 pm

    I agree that we can pick out low-hanging fruit due to the low amount of effort to get the payback. Also, it’s true that just a few major expense categories result in a big share of our total cash outflow. The decisions we make in those areas can impact our total financial situation greatly. I would say that home purchases just might be at the top of the list in a category unto itself.

    For example, somebody could be eating every meal at home and be a super frgual grocery shopper, but if he bought a dream home that was beyond reach, he might very well find himself to be worse off than somebody who eats out every meal but bought a good-enough home instead of a dream home.

    • John on 06/24/2012 at 8:57 pm

      It’s amazing how easy it is to overlook either. I’ve known many people who shrug at the idea of direct deposit into a savings account to earn interest.

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  5. AverageJoe on 06/28/2012 at 1:22 pm

    I’ve enjoyed using both of these principles over the years. I like what you did with the food budget. Awesome work with a huge payoff.

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  9. Lynn on 09/29/2012 at 12:15 am

    I have been couponing for years. I save approximately $200 a month for about 6 hours of work every Sunday. This is to reduce my spending down to $300 a month. I do not include the cost of my time, because this 6 hours is spent in front of the TV. In other words, it’s not like I’m turning down paid work to cut out my coupons.
    So I don’t quite understand the value of time lost here. Anyways, 8.75 an hour for 40 hours does not equal the $350 the average family spends on food. You forgot about income tax and the costs to work such as commuting expenses and work clothes.
    In order to organize my shopping trips with coupons, I don’t have to dress up for work or drive there. It’s my leisure time.

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