The 80/20 Rule: Pareto Principle Explained with Examples [2025]

While stock market investors rely on several rules to formulate their investment strategies, the 80/20 rule remains the most famous. But what is the Pareto Principle or 80/20 rule? How can you use it to optimise your investments? What are some 80/20 rule examples? Let’s find out how this plays out in the stock market.

The 80-20 Rule Explained 
 

The 80/20 rule means that 80% of all outcomes stem from 20% of the event's causes. Simply put, in investment terms, the Pareto distribution says that 80% of your portfolio’s gains or losses come from 20% of your investments.

The 80-20 Rule – How it Works 

The Pareto distribution is not a hard and fast rule but rather a direction for analysing your investments' performance. The 80/20 principle applies to investments and is vital today in assessing macroeconomics, finance, budgeting, trading, risk diversification, and several other avenues.

Core Idea Behind the Pareto Principle

At its heart, the 80/20 principle helps maximize efficiency by focusing on the most impactful factors. A good starting point for the Pareto Principle is to get to the biggest problem first and then gradually solve subsequent issues.

A business, for instance, may find that 20% of its customers generate 80% of its revenue. As per the Pareto chart, it should allocate resources accordingly while still maintaining other customers.

Pareto Chart – a Strict Rule?

As mentioned above, the 80/20 rule should not be misinterpreted as a strict mathematical law but as a guiding philosophy. If only 20% of an investment yields 80% of gains, it doesn’t mean that the rest of the investments should be ignored or dismissed.

History of the 80/20 Rule

The Pareto Principle was introduced in 1906 by the Italian economist Vilfredo Pareto. He observed that 20% of the pea pods in his garden produced 80% of the peas and later found a similar pattern in Italy’s economy—20% of the population owned 80% of the wealth.

Later, in the 1940s, Dr. Joseph Juran applied the principle to quality control, showing that 20% of production issues caused 80% of defects. This led to the Pareto chart, a key tool in business efficiency. Focusing on the “vital few” over the “trivial many” remains widely used across industries today.

The 80/20 Rule and its Benefits in Investments

Now that you know what the Pareto Principle is, it's time to see how it is beneficial in designing and changing your investment approach:

Hedging Risks

By parking 80% of your funds in relatively safer asset classes, you can balance out the risk associated with diversification. For instance, you can invest 80% of your funds in savings bonds, while 20% can be invested in growth stocks or 80% in a retirement account and 20% in a taxable portfolio.

Diversifying Your Trading Strategies

Also called system diversification, mixing trading strategies can allow you to maximise returns. If you find 1 or 2 trading strategies guiding 80% of your gains after analysis, you should decide when to focus on these key strategies and tweak the underperforming ones.

Deciding on Indicators

Investors rely on indicators to gauge the value of a stock. However, adding too many indicators can give you contradictory readings. Using the 80/20 rule, you can decide which indicators give you the most actionable insights and plan your strategy better.

Rebalancing Your Portfolio

Rebalancing your investment portfolio lets you trim your losses. You can minimise losses and eliminate non-profitable investments by redirecting your funds to the 20% of assets that drive 80% of your portfolio's gains.

The 80/20 Rule Examples

How does the 80/20 rule work in the US stock market? Here are a few Pareto Principle examples:

• 80% of your portfolio's returns in the market may be traced to 20% of your investments
• 80% of your portfolio's losses may be traced to 20% of your investments
• 80% of your trading profits in the US market might be coming from 20% of positions (aka the amount of assets owned)
• 80% of the US stock market capitalisation comes from around 20% of the S&P 500 Index

Conclusions on the 80/20 Rule

The 80/20 rule is not a stock market fail-safe — it's more a basis for evaluating your investments and not predicting what will earn you more. However, investing 80% in blue-chip stocks and 20% in small to mid-cap stocks may be safer if you're dabbling in the US Stock market.

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Frequently Asked Questions on 80/20 Principle

1. What is the Pareto Principle?

The Pareto Principle, or 80/20 rule, helps identify the most efficient way of doing things that will bring the most returns. In the investment world, it implies that 80% of your returns are from 20% of your holdings. The 80/20 rule is widely used in business, management, and other fields, like the US stock market.

2. What are some examples of the 80/20 rule?

Based on the application of famed economist Vilfredo Pareto's 80-20 rule, here are a few examples:

• 80% of your stock market portfolio's profits might come from 20% of your holdings.
• 80% of a company's revenues may derive from 20% of its clients.
• 20% of the world's population accounts for 80% of its wealth.