The time value of money (TVM) entails the belief that money available now is worth more than the same amount in the future due to its potential interest earnings.

Given a choice, would you rather have $500 today instead of two years from now? What makes today’s dollars more valuable? The time value of money showcases the distinction between the present and future value.

What would you choose if given the option of receiving $12,000 now or $1,200 monthly for the next ten months? By understanding the TVM, you can weigh the opportunity for growth against the consistency of recurring payments.

If you forgo collecting and investing the money now, you could lose out on earnings potential, or the person paying you could suddenly disappear after paying only four installments. Because of uncertainties in the future – in addition to interest-earning potential and inflation – current dollars are worth more than future dollars.

You must think about TVM when saving for retirement. If you don’t set enough money aside, you may retire with anxiety and stress instead of comfort. Social Security payments will likely only partially cover your living expenses in retirement, so you’ll need other income sources. 

Start saving for your retirement now. Your funds can grow over time, and that growth can compound. If you deposit $1,000 into a high-yield savings account with a 2% annual interest rate, your balance will be $1,020 next year. Over time, the earnings continue to build.

There are several formulas to calculate TVM. One example is the Present Value (PV) formula which helps us measure the equivalent value of money today compared to receiving that same amount at a future date.

The PV formula is calculated as follows:

PV = FV / [(1 + r)^n]

FV stands for Future Value, r represents interest rates, and n is the number of compound periods.

For example, let’s say you deposit $10,000 into a savings account with an interest rate of 5 percent compounded annually for ten years. According to this equation, your present value would be $6,714.11. This means that the $10,000 you deposited today will be worth $6,714.11 after ten years due to inflation and compounded interest.

Knowing the time value of money is key to making intelligent financial decisions. The concept has a significant influence on our finances. Keeping these ideas in mind can help you make sound decisions about your savings and investments.