My wife is a big fan of the Olympics so I had to watch every day along side her to cheer on our favorites athletes but since I like to tinker with numbers I decided to use my time on the couch to test the Pareto Distribution.
Pareto Distribution
For the uninitiated and from Wikipedia,
“The Pareto distribution, named after the Italian civil engineer, economist, and sociologist Vilfredo Pareto,[2] is a power-law probability distribution that is used in description of social, quality control, scientific, geophysical, actuarial, and many other types of observable phenomena; the principle originally applied to describing the distribution of wealth in a society, fitting the trend that a large portion of wealth is held by a small fraction of the population.[3][4] The Pareto principle or “80-20 rule” stating that 80% of outcomes are due to 20% of causes was named in honour of Pareto, but the concepts are distinct, and only Pareto distributions with shape value (α) of log45 ≈ 1.16 precisely reflect it. Empirical observation has shown that this 80-20 distribution fits a wide range of cases, including natural phenomena[5] and human activities.[6][7]“
What does this have to do with the Olympics? When the Olympics started, without knowing any of the odds or athletes, I suggested that 80% of the medal would be won by 20% of the participating countries.
So how did I do?
I downloaded the data from Wikipedia here. I then calculated the percentage of how many gold and total medal each country won but only till I got to the 80% mark.
For Gold medals, it took 21 out of 92 countries to sweep 80% of the medals. The ratio breakdown is 77.17 / 22.82 . Not exactly 80/20 but close enough.
For Total medals, it took 31 out of 92 countries to sweep 80% of the medals. The ratio breakdown is 66.3 / 33.7. Total medals was a bit more distorted but this included a mix of silver and bronze and I was too lazy to do the math for each medal category so total is more of a blended average.
Personal Finance & The Pareto Principle
What does all of this have to do with personal finance? Well whether it’s Olympic medals, the returns of stocks or your job prospects, it always (mostly) boils down to a systemic distribution.
When I take inventory of all the family members I keep in contact with I get a distribution not to different from the Pareto Distribution: 80% struggle financially while 20% are well or better off. I asked ChatGPT to explain why the Pareto Distribution exists and it coughed up the following:
The Pareto distribution is often caused by underlying mechanisms where a small number of factors contribute to the majority of outcomes. This distribution emerges in various natural and social phenomena, such as wealth distribution, where a small percentage of the population holds most of the wealth. The causes include:
Positive Feedback Loops: Success breeds more success, leading to concentration.
Network Effects: Larger networks attract more users or resources.
Bounded Growth: Constraints limit growth, leading to unequal distribution.
Power Laws: Certain systems inherently follow power laws, leading to Pareto-like distributions.
Once of the things we learned while watching the Olympics was that many of the athletes train in the United States no matter what country they are from because that’s where the best training can be found (Network Effects).
The same hold true in personal finance and I wrote about this in a different way in What’s Holding You Financially Back?
In that post I had the following reasons for being held back financially:
- Religion – I consider this a negative feedback loop financially in my post.
- Friends & Community – I consider this a negative network effect in my post.
- Education – Bounded growth fits in nicely here.
- Environment – Part bounded growth and power laws fits this one from my post.
- Me – A combination of all the things listed above but gratefully, I over came most of them.
Share The Wealth
So I ask again, What do you think is holding you back financially and how will you overcome? Let me know in the comments below.
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