This article, by Justin Baiocchi, was originally published in The Northern Daily Leader on 1 August 2015.
When our eldest son, Jack, was two years old, my wife and I made the mistake of letting him watch the Disney Cars movie. It must have just been the noise and the colour, for he surely didn’t understand the plot or the dialogue, but from that moment on his life revolved around Cars and the main protagonist, Lightning McQueen. And as is the way in our very commercial world, he soon had Lightning McQueen pyjamas, plates, cups, cutlery, shoes, hats, shirts, underwear, stickers and bedding. Most important of all however, is his burgeoning Cars die-cast car collection. It started with one, then two, then three and pretty soon we lost count of the number of die-cast cars he had amassed. Wherever we went, we hunted around for a different car to buy for his birthday, Easter, Christmas or just to keep him quiet for five minutes. I’ve looked for Disney Cars characters in every toy-shop from Sydney to Brisbane; I’ve ordered them online; had them shipped from London and Los Angeles and yet somehow, there still seems to be a host of the wee little devils he doesn’t already own. They’re taking over the house and now have their own bedroom and en-suite.
Interestingly, with every car we (or friends and family) bought him, his open appreciation and joy began to diminish, little bit by little bit. If his first Disney Car scored 500 on the ‘Oh Wow!’ scale, by the time we got round to handing over car no. 64, it had fallen to the measly level of 10. This is of course, probably no surprise to parents with more experience than us. His behaviour also perfectly fits a well-known phenomenon in economics – the law of diminishing marginal utility. This law describes the situation where every additional unit of something that you consume gives you less pleasure than the one before it. For example, the first prawn you eat at Christmas is incredibly delicious, but by the time you’re on your 20th prawn they taste less and less so. And so it is with Jack, whom we suspect now fakes excitement when he unwraps yet another Disney car.
When it comes to investing however, the same law of diminishing marginal utility both does and doesn’t apply. In building your investment portfolio diversification is important. Starting with zero investments, each additional investment added provides positive diversification benefits. No diminishing marginal utility here. However, once you get to around 25 investments or so, diminishing marginal utility begins to apply and each successive gain in diversification becomes less and less. Your investments may cost more than a $10 car, but the rules are the same. Now, does anyone know where I can get my hands on the Dragon Lightning McQueen?