Given the rapidly increasing number of air-conditioned buildings, the electricity demand in the Kingdom of Saudi Arabia has increased during the past decade. Efficient thermal insulation is extremely important for energy efficiency and sustainability, especially with the country’s hot-arid climate. This study explores the law of diminishing returns when improving the conservation level of residential buildings by using case study simulation. Specifically, this study aims to identify alternative positions for the insulation material and the optimum thickness for the three proposed strategies (on the roof only, on the walls only and on the roof and walls) in accordance with the energy efficiency index defined in the thermal insulation regulation of the KSA. Moreover, this study uses the life cycle cost model to manage the optimum number of insulation levels. This study also uses DesignBuilder energy simulation tool to estimate the energy performance and the environmental impact of a sample prototype villa with a gross area of 238 m2 in Najran City. The optimum insulation thickness is defined based on the cost benefits of the extruded polystyrene material (XPS) over its lifetime. Results show that the optimum insulation thicknesses of 8, 4 and 6 cm must be applied on the roof only, the walls only and the roof and walls. These alternatives can lead to reductions of 19.14%, 7.51% and 29.77% on annual energy consumption, respectively. A substantial reduction on CO2 emission is also achieved. Finally, the payback period in the three optimum alternatives are 3.73, 12.14 and 6.39 years, respectively.