Do you know anything about the time value of money (TVM)?
If your answer is no then it is alright. Most people are not really aware of it. But, it doesn’t mean you shouldn’t. If you are an investor who isn’t invested in the Forex market or any other financial market then you need to understand the time value of money. It is the concept worth to understand. But, before we tell you how the time value of money is directly related to investors, first, let’s understand what time value of money is all about.
Time Value of Money (TVM)
Time value of money also referred to a present discounted value which is more like an abstract idea that money available at the present time is worth more than the identical sum in the future due to its potential earning capacity. This core principle of finance holds for two reasons:
- Money received today can be invested in order to generate more money.
- Opting money to receive in the future rather than today means effectively lending the money which involved risks like default risks and inflation.
The idea came from the rational investor’s preference of receiving money today rather than the same amount of money in the future.
Stating the obvious but which option would you choose, if you have the option to choose between receiving Rs 10,000 now versus Rs 10,000 in two years. It is quite obvious most people would choose to receive now. Despite the equal value at the time of paying out, receiving the Rs 10,000 today has more value and utility to the beneficiary than receiving it in the future due to the opportunity costs associated with the wait. By opportunity costs means the potential gain on interest.
Why it matters to Investors?
The investors who don’t prefer to invest in the stock market or any other financial market, instead give preferences to the banking deposits and fixed deposits can use the rupee on hand today to invest and earn interest or capital gains. The rupee promised in the future is actually worthless because of inflation.
Investors can use this principle to predict the value of money in terms of present and future time period. Thus, the most fundamental TVM formula is:
FV = PV x [1 + (i/n)](n x t)
FV = Future value of money
PV = Present value of money
i = interest rate
n = number of compounding periods per year
t = number of years
The best way to illustrate Time Value of Money (TVM) is – Assume a sum of Rs 5,000 is invested for one year at 10% interest. So, the future value of money is:
FV = Rs 5,000 x (1 + (10% / 1) ^ (1 x 1)) = Rs 5,500
This formula can be rearranged to find the value of the future sum in present-day dollars. For example, the value of $5,000 one year from today, compounded at 7% interest, is:
PV = Rs 5,000 / (1 + (7% / 1) ^ (1 x 1)) = Rs 4,673.
It shows that the time value of money not only depends upon the time horizon and interest rate but also on how many times the compounding calculations are computed each year.
Final Thoughts: –
By seeing the calculations, it is clear that TVM can be used to calculate present and future value in distinguishing between the worth of investments that offer returns at different times. And it is also clear that value of the money you have now is not the same as it will be in the future. Anyways, it is our opinion which is based on the concept for the time value of money. Don’t take it for granted.
Nevertheless, if you have any query or would like to add something up then don’t forget to mention in the comment section below. We will be happy to answer all your questions.
Author Bio:
Hi! I’m Wasim. I’m a research analyst and have over 5 years of experience in the stock market. I’ve been helping many investors and digital participants in achieving their financial goals by providing proper guidance and the right resources on time. Regardless, of where you are in your life, I have skills that along with your support, we can create a strategy to get succeed. I prefer to share my skills and in-depth knowledge of stock market and other financial markets in the form of free content which you see through my articles and various blog posts which I contribute in free on multiple platforms.
Currently, I’m associated with Advisorymandi.com – a leading platform to connect investors/traders with SEBI Registered Analysts & Market Experts. The reason I with Advisorymandi is because “It believes in optimal value creation for investors/traders by keep on connecting with top performing SEBI analysts at the right time.
