Diminishing Marginal Utility of Wealth

I was recently thinking about my portfolio and particularly my aversion to risk.

In the past, I’ve told myself that I would be happy earning a nice, safe 6-8% per year. I didn’t need the 12% long-term stock market average or more risky 20%+ returns that real estate and other investors seek.

That’s because one of my main goals was preserving my current level assets. If I could keep the same level of wealth that I have today (adjusted for inflation and living expenses) into the future, I would be good for the rest of my life.

(I’ll be honest: that last sentence felt odd to write. The fact is that I am generally content or satisfied and am not scrambling to achieve much more.)

This is why I have generally had around half (40%-90%) of my investment portfolio in cash this past year. As interest rates have risen, I’ve been invested in GICs, money market funds, and short-term government bonds to earn a little interest.

Today, I came across the term “diminishing marginal utility of wealth.” It seems to fit my circumstances.

The term “diminishing marginal utility of wealth” refers to the economic principle that as an individual accumulates more wealth, the additional (or “marginal”) utility or satisfaction gained from each additional unit of wealth decreases. In simpler terms, the more money you have, the less additional benefit or happiness you get from acquiring even more money.

For example, imagine you have $1,000 in your bank account and receive an additional $100. That extra $100 may provide significant utility—it could help you pay for necessities, reduce financial stress, or allow you to enjoy a nice meal out. Now, consider a situation where you already have $1 million in your bank account. In this case, an additional $100 likely offers much less utility; it doesn’t substantially change your financial situation or quality of life.

The concept of diminishing marginal utility of wealth is often used to explain various economic behaviors and phenomena, including risk-taking behavior in investments, attitudes towards taxation, and wealth distribution policies.

For me, this is slightly different. Instead of wanting to take on more risks with my investments because a loss doesn’t hurt me, I want to take on fewer risks.

It will be interesting to see if I regret this path in 10 or 20 years. Maybe I would miss some incredible opportunity (a tourist ride into space!) because the financial cost is a significant percentage of my net worth. But if I had focused on increasing my net worth instead of preserving it, I might have been able to justify the cost.

Oh well, this is the path I have chosen for now.

I will forgo the 25% annual returns with certain riskier investments for an excellent 6-8%.