Diminishing Returns Explained: A million in a 401k is about enough

So this blog is named the “The Blog of Diminishing Returns.” Part of the goal of the blog is to explain basic economic concepts. So today we take on the blogs title. Everyone has experienced diminishing returns, it is your realizations that you not gotten as much done the 11th hour of the all nighter you are pulling as the first hour. Economists usually look at marginal product (that is the production one more hour working). Many times when you produce something after a while the benefits from working an extra hour starts falling or may even become negative. When the extra product of working one more hour is less than the last hour you have hit diminishing returns.

A related concept is diminishing marginal utility. In this case utility is just a measure of how happy something makes us, so if something has diminishing marginal utility the extra benefit we get from one more keeps falling. Think of when you are hungry how happy the first slice of pizza makes you compared to the fifth. Yes the fifth pizza slice makes you happy, but not as happy as the first slice did. At some point the 15 slice may even make you lose all your utiles!
So on that note, a reader asks a question on these lines.

“I am curious if there is a breakeven point and/or a point of diminishing return for someone in their late 40's early 50's to stop contributing to their 401k and just spend the contribution money and enjoy life?”

Yes, here is why. Imagine you had a 10 million dollars, how much extra happy would you be (a lot?) Imagine if Bill Gates had 10 million more dollars would he be much happier, probably not. So for the most part economists assume money has diminishing marginal utility at some point. What is the decision here it is spending today versus saving for retirement? Because of diminishing marginal utility it is probably best to spread out your money a bit between now and retirement. However, as economists would point out most people would rather have something today then 20 years from now (since we might not make it 20 years), so having a dollar in retirement is worth less than enjoying it now. So factoring that all in.

Taken to extreme if you had 5 million dollars in your 401k and you were 40 and wanted to live off of 200,000 a year you could probably stop contributing to your 401k, given that with savings bonds you could easily cover that.

So where exactly is that cutoff point. I don’t know, but I think a good idea can be found in a paper by Jonathan Skinner in the Journal of Economic Perspectives. His basic analysis says it clearly depends on the household, but if you are in your late 40s to early 50s and have a million bucks in your 401k and want to live off of less than 200k year. Dr. Skinner basic conclusion is that you have reached that point and should spend some money now. See his linked paper, which should be quite readable, particularly Table 2 on pg 66.

Back to Bill Gates and his buddy Warren Buffett. At this point they are giving away lots of money, perhaps diminishing marginal utility does not sink in so fast with charity as it does with pizza. So perhaps it is time to give more money away and let other people enjoy life.