What is the Time Value of Money?

One common criticism of public school systems is that there is little or no attention that is paid to the fundamentals of savings and investments. Since large percentages of the population do not make it past high school, it does make sense that there are major deficiencies here, and that more time and effort should be paid to educating the masses in these areas. One of the most important lessons that should be understood by anyone with a bank account or an investment portfolio is the “time value of money,” as its implications can be significant when looking at your financial stability over the long term.
The time value of money is essentially assertion that money available currently is more valuable than an equal sum of money in the future. The reason for this lies in its capacity for potential earnings and the historical tendency for inflationary pressures to build. This principle is one of the foundational ideas of personal finance and is directly related to the fact that money borrowed today will only accrue interest in the future. This also means that money that is received sooner is worth more than money received later. This concept is also referred to as money’s present discounted value.

Money Saved vs. Money Invested The time value of money has drastic implications for the way each individual should approach their savings, investment plans and financial goals for the future. “It is commonly understood that money placed in a savings account will gain interest over time,” said Ann Gorenkova, markets expert at NordFX . “But this fact also creates the basis for the reasoning that money held today is worth more than money to be received tomorrow.” For these reasons, it always makes sense to receive money today, rather than to receive the same amount at a later date. This raises some important questions both for those looking to earn additional income through investments or to save for retirement plans later on in life.

Hypothetical Example
To better understand the principle, let’s take a look at a hypothetical example. First, let us assume that you are offered 5% interest for an amount of $100 that is invested tomorrow. That same $100 would be worth $105 a year from now, as we take the amount invested ($100) and multiple this figure by the interest rates (1.05). At the same time, if that $100 was instead received a year from now, it would be worth less than $95.25 today (as we would divide the $100 by 1.05). In all of these cases, the variables are the same: $100 and an interest rate of 5%. What is different in these two scenarios is only the time factor, and here we can see the time value of money at work.