Imagine that someone asks you whether you want Rs. 1,000 today or the same amount five years from now. Which would you choose? Most people would instinctively want the money now, recognising that it holds more value today than it would in the future.
 

This intuition is the basis of the time value of money (TVM), a concept that drives many financial decisions and investment strategies. But how exactly does TVM influence your investments? Find out in this article.

• The time value of money (TVM) tells us how present money can grow over time.
  

• Early investments harness the power of compounding, yielding greater future returns.

• Ignoring the time value of money results in missed opportunities and suboptimal decisions.

• Applying TVM helps you set realistic long-term investment goals.

In simple words, the time value of money is the idea that an amount of money has greater worth now than the same amount in the future. This is because the money you have today can be invested or saved, earning returns or interest, adding to its future value. So, TVM reflects the potential for money to grow over time through investments. This concept says that a Rs. 100 note in your pocket today is more valuable than the same note tomorrow.
 

The concept can be broken down into two parts:

• Present Value (PV): This is the value today of a sum of money that you expect to receive or pay in the future. Essentially, PV answers how much your future money is worth today.

• Future Value (FV): This is the amount of money you expect to have at a future date, based on its current value, interest rates, and the period of investment. FV shows how much your current investments will grow over time.

TVM can be calculated using a straightforward formula. Understand how the present and future value of money can be calculated through this simple example.
 

Present value formula:

PV = FV/((1 + i/n)^(n x t))

In this formula

• FV is the future value

• i is the interest rate

• n is the number of compounding periods per year

• t is the number of years

Consider that you expect to receive Rs. 10,000 in three years and the annual interest rate is 6%. To find out what the Rs. 10,000 is worth today, you can use the Present Value formula:

PV = 10,000/((1+0.061) ^(1 x 3)) = Rs. 8,396.76

This shows that the value of Rs 10,000 3 years from now is equal to Rs 8,396.76 today, given the interest rate of 6%.
 

Future value formula:

FV = PV x ((1 + i/n)^(n x t))

Using the same example as above, if you invested Rs. 8,396.76 at 6% interest for three years, the future value would be Rs. 10,000.
 

The calculation shows us the importance of interest rates, the length of time for which you invest, and the compounding frequency. A higher interest rate or more frequent compounding periods would yield even higher returns.

The time value of money plays a key role in your investment decisions. Here is how understanding this concept can influence your approach:

• Compounding effect: TVM illustrates how compound interest works to grow your investments. The longer you invest, the greater the returns.

• Impact of inflation: TVM helps you account for inflation, which reduces your purchasing power over time. By investing, you can counter inflation and preserve wealth.

• Risk and return balance: Higher-risk investments typically offer higher returns over time. TVM helps you evaluate whether the future return justifies the current risk.

• Optimal investment timing: The earlier you invest, the more time your money has to grow. TVM encourages early investing to maximise future returns.
   

Based on these insights, you can apply the following maxims to your investment decisions:

1. Start early: Give your investments as much time to grow as you can. With time, the value of your money grows exponentially due to the power of compounding.

2. Assessing investments: Pick investment options that can counter inflation. These are instruments that offer higher returns compared to the rate of inflation.

3. Aim for stability: Spread your investments across various instruments to balance risk as you attempt to maximise the future value of your money.

The time value of money is a powerful tool that can reshape how you think about investing. By recognising that money grows over time, you can make more strategic decisions that exploit the power compounding.
 

Whether you are investing for retirement, a home, or simply building wealth, understanding and applying TVM can make all the difference in achieving your financial goals. The earlier you start harnessing TVM, the better positioned you will be to reach your future milestones.
 

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