The marginal utility of Money

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The American multimillionaire, John D. Rockefeller, was once asked, “How much money is enough?” His answer: “Just a little bit more.

If you ask yourself the same question, what will your answer be? A crore, a 100 crores or somewhere between the two. You ask 100 people and you are likely to get 100 different responses.

The underlying fact is that you don’t know how much is enough. And that results in an endless chase for acquiring money, sacrificing almost everything else in the bargain because you don’t know what do you need the money for?

What do you need the money for?

Don’t I sound foolish to ask that? You need money to do almost everything – from meeting the most basic needs of food, clothing and shelter to fulfilling your dream desires; From running the household to paying school fees and going on that dream vacation.

Then, of course, you have to plan for the future goals too such as providing for your own retirement, higher education for the kids, that vacation house, etc.

But what after that? Once you have provided for all these, what else will money get you? More things? More happiness?

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Psychological research finds that once you have met your core needs and goals, the increase in the money or wealth does not result in a similar increase in level of your happiness. In fact, after a point, an increase in money does not make any difference to how happy you are.

You would tend to agree. Why?

Law of Diminishing Marginal Utility

An important law in economics is that of diminishing marginal utilityThe law states that after a certain point, with every marginal unit increase in consumption of a product, the utility derived from the additional unit keeps diminishing. 

To understand it another way, it means that if you were to eat chocolates, the first few bites would give you immense pleasure, but with the 6th or 7th or the 8th or nth bite, the pleasure would start to diminish. Finally, at one point, you would just say NO.

This law is at work with money too. As mentioned earlier that after a certain point, increase in money or wealth will fail to increase your happiness. Call it the Law of Diminishing Marginal Utility of Money.

The question is at what point would you say – “I don’t care”.

The True value of Money

In the study of economics, while discussing utility, one comes across the paradox of water and diamonds. Between the two we will place a far lower value on water and a far larger one on diamonds, even though water is vital for your living.

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Ah! The world we live in!

The fact is that diamonds or money can’t buy you happiness. The true value of money lies in the fact that it allows you to have the time that you can spend in ways you want to, that is, travel, reading books, spending time with family and kids, pursuing your hobby, or, just being…and they are truly priceless.

Here’s what Warren Buffett, had to say in response to a question.

There are things money can’t buy. I don’t think standard of living equates with cost of living beyond a certain point. Good housing, good health, good food, good transport. There’s a point you start getting inverse correlation between wealth and quality of life. My life couldn’t be happier. In fact, it’d be worse if I had six or eight houses. So, I have everything I need to have, and I don’t need any more because it doesn’t make a difference after a point. When you get to 10 times or 100 times or 1,000 times, it doesn’t make a difference [in quality of life]

The takeaway is that it makes great sense to know how much money is enough for us and avoid the rat race of just having more than someone else.

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Here’s a thought I leave you with.

The real measure of your wealth is how much you’d be worth if you lost all your money.

This should also help you get you to think about what your life is driven by – Money or Purpose.

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Vipin Khandelwal
Vipin is a SEBI Registered Investment Adviser. He works with investors to make better decisions and create behaviour alpha.
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