In 1906, economist Vilfredo Pareto developed a mathematical formula to describe the distribution of wealth in Italy. Pareto observed that 20% of the population owned 80% of Italy’s wealth. Experts across a variety of disciplines found that the Pareto principle applied to many situations. The “80-20 rule” was born.
The 80-20 rule is one of my favourite rules, as it applies to your life and everywhere you look. Examples:
20% of efforts generate 80% of your results.
20% of your customers account for 80% of your profits.
20% of your activities account for 80% of your happiness.
Once you “get it,” you’ll see examples of the Pareto principle everywhere you look.
But the Pareto Principle also works in investing because you will find that approximately 80% of your gains result from 20% of your investments.
Therefore, the Pareto principle shows that the key to making money in stocks is to bet big on a handful of big winners:
1. Pick your stocks carefully. When you invested in a top performer, hang on to it.
2. Be ruthless in cutting your underperformers.
When you stick to these 2 simple rules, this will make all the difference.
Sven Franssen