The Law of Diminishing Returns & Personal Finance




As human beings, we have the intellectual capacity to recognize that having certain things in our lives can add function, safety, entertainment, comfort, and even happiness at times.

For example:

  • Getting quickly from point A to point B adds value through function.
  • Having four walls and a roof surrounding us adds value through safety and comfort.
  • Having insurance adds value through removal of risk.
  • Having gadgets adds value through function and entertainment.
  • Having food adds value through removing hunger and adding comfort (and great taste).
  • Having proper clothing for whatever weather the day brings adds value through comfort and safety.
  • Having money adds to our ability to purchase more of all of the above.

And that last point is where things get a bit tricky. Our brains are very adept at recognizing when a basic need is met and adds significant value to our lives. There is surely an element of primitive survival at play here that is followed by all living creatures. Our neural wiring allows us to recognize value and then encourages us to repeat.

While this primitive neural wiring improves our chances at survival, it is dumbfoundingly inept at determining much more than that. It screams at us to get “more, More, MORE!!”. It doesn’t have a shut-off valve for consumption. It doesn’t understand modern abundance, inventions, and marketing tactics. It just begs for “more” with the promise of better survival (which we label as “happiness”). The thought pattern often goes like this…

  • Getting quickly from point A to point B is great, but getting there MORE quickly or MORE comfortably or MORE fancifully would be even better, and make me happier.
  • The safety and comfort of four walls and a roof is great, but having MORE space and features between and outside of those walls would be even better, and make me happier.
  • Having insurance to remove risk is great, but having MORE insurance would remove even more risk, and make me happier.
  • Having gadgets to consume entertainment is great, but having gadgets with MORE speed, MORE style, and MORE function would allow me to consume even more entertainment, and make me happier.
  • Having food to remove hunger, increase comfort, and delight my taste buds is great, but having even MORE food would make me happier.
  • Having proper clothing for whatever weather the day brings adds comfort and safety, but MORE comfort and style would make me happier.
  • Having money adds to my ability to purchase more of all of the above, so MORE money would make me even happier.

The reality is that there are diminishing returns on the output of “more”. Always. Hence, “the LAW of diminishing returns”.

The functional return of going from walking to a bike or basic vehicle is huge. The return on going from a basic vehicle to a luxury vehicle is much less, and from one luxury vehicle to an even fancier one is even fewer. Yet, the costs associated with each jump goes up at a much higher level, often exponentially.

The functional return of going from a 1-bedroom apartment to a 900 square foot 3 bedroom home with a garage is huge. The return of going from the 3 bedroom to a 5-bedroom, 3-car garage is much less and – in my opinion – might even be negative.

The functional (and happiness) return on going from a $50,000 to a $2 million retirement nest egg is huge. The return on going from a $2 million nest egg to a $10 million nest egg, in my case, would be nearly zero. Yet the cost of time investment would be decades of my life.




You probably get the idea, so I will spare you further examples. When applying the law of diminishing returns to consumption of a particular type, the graph typically looks like some variation of this:

law of diminishing returns

One of the core tenets of personal finance success is to understand and embrace the law of diminishing returns with almost every purchase (and certainly with all of the big ones). Your lizard brain is telling you “more!”, but you have to override it with the logical part of your brain. Gratitude helps a lot with that.

It takes discipline and practice and you’ll probably take the bait many times, but consider it a must if your financial journey is to be a successful one.

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8 Comments

  1. missy@ omg photos
  2. B.A.
  3. Dan
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