80/20 Debt Reduction

LeverageIn examining my own debt, I apply the 80/20 Rule. This rule says that 20% of inputs create 80% of outputs. On the flip side, 80% of inputs create only 20% of outputs.

This rule is not always 80/20. Sometimes it is 95/10 or perhaps even more lopsided.

The point is that not all actions have equal results. Some small actions produce a big effect. Some big actions produce only a small effect.

How does this apply to debt reduction?

For one, you may have already heard of “snowballing.” This is where you pay the minimum payment on all outstanding balances except for one. You then use all your excess money (say $200 a month) to pay down this balance as rapidly as possible.

After this initial balance is paid off, you pick a new balance to eliminate. This time, you take all the money you were paying to the previous balance ($200) and add your current minimum payment from the new balance you’re attacking (say $50). So now you’re paying$250 to this second balance.

When you get the third balance, you roll in the minimum payment you are paying, plus the $250. So with the third balance, perhaps you are making a monthly payment of $285. And so on.

If your financial resources are diffused among all your balances, you won’t make headway very quickly. But by applying the 80/20 Rule, you get faster results. You are acting on the fact that 20% of your inputs (dollars in this case) are creating 80% of your results (decreasing the balance of one account).

You can also apply the 80/20 Rule to eliminating expenses. Make a list of all your monthly expenses. Focus on how you can decrease the largest monthly expenses first. Only tackle smaller expenses until you’ve dealt with the large ones.

A lot of folks waste hours of their time to save a nickel. This, in my opinion, is foolish. At the end of the month, a nickel–even a lot of them–won’t add up to much.

Example #1: Instead of downgrading a Netflix account and saving $4 a month, focus on how to eliminate a car payment. That could save you anywhere from $150 to $600 a month, depending on your vehicle and the size of your loan.

Example #2: Let’s say you want to spend less money on gas for your car. Instead of focusing on how to drive more miles per gallon (by, for instance, regularly checking your tire pressure), focus on driving less. You might save $2 or $3 a month by improving your gas mileage. But you could easily save $10 to $50 a month by driving fewer miles.

Do you see how this works?

I remember reading some of the suggestions in The Complete Tightwad Gazette, a collection of newsletters by Amy Dacyczyn. Some of the ideas included making your own laundry detergent and reusing coffee grounds. I don’t know about you, but I’m not interested in sacrificing hours of my time or personal enjoyment to save a couple bucks a month. (Of course, if you love making detergent or drinking weak coffee, by all means pursue your passion.)

I also realize some folks enjoy frugality for frugality’s sake. In other words, it’s a game. I can understand that. But if your motivation is simply to reduce debt and reduce expenses to help you along, then the 80/20 Rule is a beautiful thing. It focuses your energies where they really count.

This is the reason why I’ve focused on reducing major monthly expenses like my house payment and how much I was paying my brother. These expenses eclipsed all others. So it made sense to focus on them first.

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