The 80/20 principle says that 80% of effects can come from 20% of causes. This principle, commonly referred to as the Pareto Principle, shows up in economics, science, finance, and a host of other areas. A good example is the fact that about 20% of drivers cause 80% of accidents. The big idea isn’t that the ratio is always 80% to 20%, but rather that results can be predictably unbalanced. For example, say you are trying to lose weight. You decide to eat healthy foods, but you still overeat. You will not lose weight because there is a bigger cause at play, your caloric intake.
Now, obviously this is a guiding principle and not a law. In my experience, and I am sure in the experience of countless others, when we look to save money and be frugal, the VAST majority of our results will come from reducing our spending in two major areas. Housing and transportation. These two expenses are 80% of frugality results. We would be wise to not major in minor things. Eating at home is nice and advisable, but address the elephants in the room first.
Don’t Buy More House than you Need
What is the single most expensive purchase you are likely to make in your life? A home. When we purchase a home, we are looking for safe neighborhoods and good schools, and perhaps even status. This is where many people go wrong. Instead of buying a home that fits our needs (safe neighborhoods and schools), we buy one that satisfies our wants (status etc.). For example, a pool would be nice, but a community pool is just as good (probably better). We may also want two guest bedrooms, but realistically, who has guests over more than a few times a year? Little desires like these can push us to buy a home at the upper limit of our means. I wrote an article about wise practices in home and car purchasing.
If that isn’t proof enough that we should be frugal in our purchase of a home, consider the major level of inflation in the size of homes over time.
People and families haven’t gotten bigger (well…maybe we’ve gotten heavier haha), but the size of new homes is steadily climbing. What major elements do you remember lacking from your childhood home? Chances are our appetites have just gotten bigger. When choosing a home, if we are frugal, the savings are astronomical. Couple this with modest investment knowledge, and the path to financial independence is much closer than one might think. Not to mention that bigger houses have bigger utility bills and larger maintenance costs. And, this is just my opinion, but when the second housing bubble pops and future generations look toward efficiency rather than excess, many of these gargantuan homes will suffer losses.
Buy a Modest Car
The next big purchase is a car. If you are lucky and live in an area with good public transportation, you may be able to get by without even having a car. But chances are it is a necessary expense. One of the most ill-advised financial decisions we can make is to buy a new car. Mr. Money Mustache provides great wisdom on frugal approaches to buying a new car. Although extreme, the mental image of setting $20,000 on fire is effective. A new car is just one of the stupidest things to buy unless you are very wealthy and can afford it off of interest income.
The reason buying a new car is stupid is (at least) two-fold. One, the value of your car immediately decreases after you drive it off the lot. But two, you have just weakened your frugality muscle by giving in to consumer culture. This is likely to increase your desire for more luxuries along the way. This is a surefire way to derail you efforts at becoming financially independent.
Hopefully you gained some useful insights into why homes and cars are the two biggest areas in our lives in which we need to be frugal. Thanks for reading!