Hermaphroditic animals face the fundamental evolutionary optimization problem of allocating their resources to their male versus female reproductive function (e.g., testes and sperm versus ovaries and eggs) and this optimal sex allocation can be affected by both pre- and postcopulatory sexual selection. For example, local sperm competition (LSC)—the competition between related sperm for the fertilization of a partner’s ova—occurs in small mating groups and can favor a female-biased sex allocation, because, under LSC, investment into sperm production is predicted to show diminishing fitness returns. Here we test whether higher testis investment increases an individual's paternity success under sperm competition, and whether the strength of this effect diminishes when LSC is stronger, as predicted by sex allocation theory. We created two subsets of individuals of the simultaneously hermaphroditic flatworm Macrostomum lignano—by sampling worms from either the highest or lowest quartile of the testis investment distribution—and estimated their paternity success in group sizes of either three (strong LSC) or eight individuals (weak LSC). Specifically, using transgenic focal individuals expressing a dominant green fluorescent protein marker, we showed that worms with high testis investment sired 22% more offspring relative to those with low investment, corroborating previous findings in M. lignano and other species. However, the strength of this effect was not significantly modulated by the experienced group size, contrasting theoretical expectations of more strongly diminishing fitness returns under strong LSC. We discuss the possible implications for the evolutionary maintenance of hermaphroditism in M. lignano.