The Law of Diminishing Returns in Personal Finance

So, ya know that feeling when you’ve had just the right amount of your favorite dessert? That first bite is pure heaven, the second is delightful, but by the fourth or fifth… well, it’s just not hitting the same way anymore. Btw, this just happened to me when I ate this gigantic piece of bread pudding. Anyway, that’s exactly how we can understand the law of diminishing returns. Let’s look at how this interesting concept plays out in our financial lives, and how we approach can money management.

Understanding the Law of Diminishing Returns: More Isn’t Always Better

The law of diminishing returns is one of those economic principles that sounds kinda complicated but it actually shows up everywhere in our daily lives. In its simplest form, the law of diminishing returns states that after a certain point, adding more of something produces smaller and smaller benefits. For example, let’s think about watering a plant.  The first bit of water brings it back to life, but keep pouring, and you’ll eventually drown it. More isn’t always better. 

This concept first clicked for me several years ago when I was obsessively checking my investment accounts multiple times a day. I was new to personal finance and learning about investing. It was like I had this thinking that more attention meant better returns. Spoiler alert: it didn’t. Haha. In fact, it was causing me more stress and anxiety than benefit. Eventually the more you look or check it isn’t providing any grater returns or improvement. Now in the beginning, of course it helps to understand how the market performs, get familiar with any volatility. But eventually, you’ll encounter a law of diminishing returns. More isn’t always better. 

How Diminishing Returns Shows Up in Your Money Life

The Savings Paradox

Let me share something that might sound counterintuitive: there’s such a thing as saving too much. I learned this the hard way when I was saving every spare penny into my emergency fund. The first $1,000 was super important. This helped me sleep better at night. Then adding enough for around 4-6 months of living expenses added another layer of security. But by the time I was able to save enough for 9-12 months in my emergency fund, any more saved wasn’t really providing the same peace of mind anymore.

The diminishing returns principle here taught me that while having an emergency fund is essential, however, there’s a point where those additional funds could be better invested elsewhere or in other accounts. 

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