FINANCIAL LITERACY AND THE TIME VALUE OF MONEY
With interest rates near 14-year highs, we should revisit the phrase, “Time is Money.” You may have even used the phrase yourself. It has special meaning when applied to investing and financial planning. Lyle and I are happy to present our “Time Value of Money” lesson, taken directly from Your Total Wealth. Anyone hoping to become financially literate should know how Money and Time interact. The time value of money concept is now more important than any time since 2008.
TIME VALUE OF MONEY
Would you rather have $1 million dollars today or $1 million five years from today?
Almost surely we all would say “today.” We would choose the money now without hesitation, almost reflexively. Why is that so?
The answer is simple: Money in hand today is worth more than that same amount at some time in the future. This differential value of the same amount of money today versus tomorrow defines the time value of money. Aside from the psychological benefit of immediate versus deferred gratification, there are two financial explanations for the time value of money: inflation and investment opportunity.
First, inflation. How many times have you heard someone say: “I remember the good old days when things weren’t so expensive”? If only you could have $10 every time you did; you would not need this book to increase your wealth.
It’s true, your money did buy more in the “good old days.” The purchasing power of $10 today is less than it was 10 years ago, and greater than it will be 10 years in the future. Blame inflation. To quote Yogi Berra, “A nickel ain’t worth a dime anymore.”
Now, lost investment opportunity. Time allows today’s dollars to increase in value if those dollars are invested at the competitive and prevailing interest rate and that interest compounds over time. Indeed, money has the potential to earn money, but that potential depends on your decision to make money work for you by leveraging the passage of time. How much will X dollars be worth in the future? Formulas at the back of this book answer that question.
You now have another interpretation for the axiom “time is money,” and this interpretation goes well beyond counting minutes and hours, or monitoring the labor purchased during those hours. Inflation and lost opportunities are silent thieves, stealing from your account. So, if you have a choice between taking the same amount of money now or later, take it now and thank your good fortune later. Plan for the future but live for today.