The time value of money is the principle that one can earn interest by lending or borrowing. It is also known as compound interest and the idea on which a central banking system rests. The U.S. dollar’s discount rate over other economies has largely been attributed to its low-interest policy in order for consumers to have more disposable income available for spending, but there are many other factors at play within our global economy with regards to economics, including inflationary pressures and debt levels

The “time value of money example” is a question that many people ask. The time value of money is the amount of money that can be earned or lost in a given period of time.

What's The Time Value Of Money?

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Many individuals in the personal finance world think about money using the Money’s Time Value (TVM) idea. This notion allows you to consider how much money might be worth if it were invested.

I believe that is an intriguing subject worth discussing. However, we should be cautious in applying this approach because it may encourage some people to overthink their costs and comprehension.

So, let’s look at what the time value of money is and how we might use it.

Time Value of Money

Any amount of money has the potential to make money. You could, in fact, put this money into the stock market (or in another investment instrument).

Money has greater worth today than it will have in the future, according to the time value of money idea. This suggests that receiving money now is preferable than receiving it later.

When we speak about the time value of money, we usually mean the worth of money in the future, expressed in years. For example, we want to know what 1000 USD will be worth in 10 or 20 years.

Because it shows how much money may be valued in the future, this notion is also known as the future value of money.

The formula is simple.

The compound interest formula makes calculating the time worth of money very simple. The fundamental formula is as follows:

(N*T) = V * (1 + (I/N))

TV stands for “time value of money,” V for “current value,” I for “interest rate,” N for “number of compound periods each year,” and T for “years.”

We may simplify the calculation by using N=1 since we usually speak about annual returns:

V * (1 + I)T = TV

Examples

Now that we’ve figured out the formula, let’s look at some instances.

For example, assuming a 5% yearly return, 1000 CHF presently has a future worth of:

  • After 5 years, you’ll have 1276 CHF.
  • After ten years, the value is 1628 CHF.
  • After 20 years, it’s worth 2653 CHF.

Alternatively, a 5000 CHF investment with a 7% annual return has a future value of:

  • After 5 years, you’ll have 7012 CHF.
  • After ten years, the value is 9835 CHF.
  • After 20 years, the value of the CHF is 19348 CHF.

These instances demonstrate that if money is invested appropriately, it has a huge profit potential.

Limitations

It’s vital to keep in mind that the time worth of money is usually an estimate.

If you have a fixed interest rate, you should be able to use this formula to get accurate figures.

However, when we discuss stock market returns, we are referring to long-term average returns. In a few years, the time value of money makes little sense. However, after ten years or more, it begins to make sense.

We never use monthly average returns since the stock market compounds monthly. As a result, it will become even less accurate.

Nonetheless, as long as we understand that this is an estimate, the error is unimportant.

Finally, while discussing the future worth of money, inflation must be taken into account. As a result, we should focus on genuine results (after inflation). Otherwise, the quantity of money you get will not be indicative of your buying power in the future.

When it comes to inflation, negative inflation has the same impact as returns. Because of the negative inflation, the value will be worth more in the future. However, persistent low inflation is uncommon, and we should not expect one.

What is the best way to apply this concept?

This principle may be used in a variety of ways.

Realizing the importance of investing and compounding interest is the most significant approach to apply this principle. It demonstrates that if money is invested for a long time, it may increase fast.

This notion may also be used to choose between different investments. If you have to select between many investments that all yield the same amount of money, go with the one that gives you the money first. Indeed, the earlier you get the money, the greater its time value will be.

Another excellent use of this tool is for saving. For example, if you can save 1000 CHF on certain purchases, you will not only save 1000 CHF today, but you will also get 4321 CHF in 30 years (5 percent returns). This demonstrates how spending less and investing the money may pay off in the long term.

This is a fantastic tool for estimating how much money you’ll need to achieve financial freedom. 4321 CHF might be one month’s worth of expenses in the prior scenario. So, by putting aside 1000 CHF, you will have one additional month of freedom. This is not insignificant, and it may aid in determining the impact of your savings.

Don’t let yourself get carried away.

The second application of this notion is when a lot of individuals get carried away.

This concert may be used to plan your costs. For example, a new computer purchased for 2000 CHF has a 20-year time value of money of 5305 CHF (at 5 percent returns). Over the same time span, a new automobile for 25’000 CHF has a time value of 66332.

When planning for the future, this might help you analyze how much you are truly spending.

Some individuals apply this principle to each cost, believing that by not spending this amount, they will gain the future worth of money. This is a fantastic tool when utilized responsibly. However, if you do this for every expenditure, you could go insane and not spend anything.

The most well-known example is the ridiculous example of everyday coffee. If you save 3 CHF by not drinking this coffee, you will have almost 13 CHF saved for retirement in 30 years. If you do it 200 times a year, you will have about 2600 CHF when you retire.

Why give up your regular coffee if it makes you happy or enhances your day? Will this 2600 CHF make you happy in retirement? That’s quite improbable.

So, don’t let this rule fool you into believing you can’t spend anything. Do something that makes you joyful! However, this tool may assist you in putting a current cost in context with what it symbolizes in the future.

Cost of Opportunity

You may also calculate an opportunity cost using the time value of money formula.

The cost of not investing money instead of keeping it in cash is the most common kind of opportunity cost. So, the opportunity cost is the difference between the money’s current worth and its prospective value. The opportunity cost of not investing 1000 CHF over 20 years at 5% is, for example, 1653 CHF (2653 – 1000).

The cost of deferring payment is another opportunity cost. Starting employment a year later, for example, might have a significant opportunity cost. This is why doing lengthy research may have a high opportunity cost. Of course, people want better pay, but it will take them a long time to recoup the opportunity cost of earning money now rather than later.

Conclusion

The time value of money is a fascinating idea that may aid in determining the true worth of money when it is invested. This is an excellent reason to invest money early in order to maximize its possibilities.

However, it is often misused, and many individuals are driving themselves (and others) insane by utilizing it at all costs. This notion does not make sense to me when applied to a single cup of coffee (or even the stupid daily coffee example).

However, applying this to the savings you can make on a large purchase makes logical. For example, when I examine a cost-cutting measure, I occasionally use this notion to evaluate how much of a difference it will make in retirement.

I advocate investing in the stock market if you have money to spare. If you don’t have any money to invest, here are some suggestions on how to save money in Switzerland.

So, how about you? Have you used this notion before?

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The author of thepoorswiss.com is Baptiste Wicht. He recognized he was sliding into the lifestyle inflation trap in 2017. He made the decision to reduce his spending while increasing his income. This blog chronicles his journey and discoveries. In 2019, he plans to save more than half of his salary. He set a goal for himself to achieve financial independence. Here’s where you may send a message to Mr. The Poor Swiss.

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The “time value of money” is a system that determines the worth of money at different points in time. The advantages and disadvantages of the time value of money are discussed. Reference: advantages and disadvantages of time value of money.

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