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The Law Of Diminishing Returns And How It Relates To Investing

Mar. 10, 2015 2:56 PM ETQQQ, SPY, TSLA, VFINX37 Comments


  • The law of diminishing returns is a well-known phenomenon in economics.
  • But it also applies to many other instances in life.
  • As it turns out, it also has implications for your investments. And not in the most obvious of ways, either.

If you've ever gone through an economics course, or read some kind of book on economics, you've probably already been exposed to the "law of diminishing returns". This law states (Source: Encyclopaedia Britannica):

… that if one input in the production of a commodity is increased while all other inputs are held fixed, a point will eventually be reached at which additions of the input yield progressively smaller, or diminishing, increases in output.

This is seen over and over in economic activity. There are lots of things where production can be increased by adding more of a given ingredient, but eventually you hit diminishing returns/productivity. For instance, it happens when you add more and more fertilizer in agriculture.

But the interesting thing is that the law does not confine itself to just economics or industrial production. It also works in many other settings. For instance it applies to sports. Training will improve your performance. But at some point, adding more training will just lead to small improvements, no improvements at all, or even regression in your ability.

Another such setting is the acquisition of knowledge in any given field. If you make an effort to learn something, you will get a return from it. But as you get closer and closer to the state of the art in that field, your knowledge will increase ever slower. Were you to reach the state of the art, and you'd have to advance it yourself - which would be an even slower process.

There is another angle

There's also another angle to the law of diminishing returns. As much as you get lower and lower returns for additional effort when you are already proficient, you get much higher returns from your initial efforts.

Recognizing this, you can already see how it can have a

This article was written by

Paulo Santos profile picture
Leader of Idea Generator
Our goal is to beat the S&P500 and to provide consistent positive returns.

Portuguese independent trader and analyst. I have worked for both sell side (brokerage) and buy side (fund management) institutions. I've been investing professionally for around 30 years.

I have a Marketplace service here on Seeking Alpha called Idea Generator that's focused on deep value, real-time actionable ideas based on valuation and catalysts. The Idea Generator portfolio has beaten the S&P 500 by more than 74% since inception (2015).

I can be reached at paulo.santosATthinkfn.com.

Analyst’s Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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