I clearly remember riding in the backseat of a friend’s car a few years ago and listening to her mom talk to her daughter (my friend) about something involving finance and car insurance. To this day, I am only able to recall 5% of their long and winded conversation; I have internalized, however, the adage she gave me that “one hundred dollars today is worth more than one hundred dollars tomorrow” let’s analyze what she meant in this blog post.
TVM (Time Value of Money) is a core principle of finance that illustrates an original investment, that can earn interest eventually, is worth more the sooner it is received. This makes sense because if you have the choice to begin earning interest (more money) on a sum of money even two days earlier, then you are better off. People should also want money sooner than later because the ability to invest money in securities (either stocks or bonds) has the potential to pay off well in the future, increasing the value of your original investment—securities relate to any tradeable financial asset whether that be common stock or bond.
The formula to find the TVM is super simple, so feel free to use it when determining the value of your next investment:
FV = PV x [ 1 + (i / n) ] (n x t)
- FV = Future value of your money
- PV = Present value of your money
- i = interest rate on your money
- n = # of compounding periods/year
- Yearly Compound= 1; Quarterly compound= 4; Daily compound= 365
- t = # of years
We will explain the wonders of compounding interest rates in another blog post, but for now, here is a hypothetical situation:
A friend offers to give you $100 at 6% annual interest rate today or $105 one year from today. Which should you take? Hint: Use the formula to help solve!