What is the Time Value of Money?
The time value of money is the idea that the money you have now is worth more than the same sum in the future because of its potential earning power.
Investors and the Time Value of Money
Most investors would prefer to receive money today rather than the same amount some time into the future. This is because investors know that money has the potential to increase in value over time if invested with financial skill.
Why is the Time Value of Money Significant?
The time value of money idea is important because it can influence investment choices. For example, an investor could be faced with deciding about investing in two projects that seem identical but are different when the time value of money concept is applied. When the investor learns that one project promised a 20% payout in year 1, and the second project offers a 20% payout in year 5, the time value of money concept would let the investor know that the investment that would pay out the 20% profit in year 1 is more attractive than the second investment because it has a higher present value.
In your personal finances, you likely make decisions based on the time value of money concept fairly regularly. If you invest money in a financial instrument like a Guaranteed Investment Certificate (GIC) and calculate the accumulated interest you plan to earn over a stated amount of time, you have determined the future value of the investment based on the amount of interest that will be compounded. Investments like this are great examples of using the time value of money in a personal finance scenario.
Elaine Allan, BA, MBA
Technology & Business Blogger
Vancouver, BC, Canada