When we talk about currency, the thoughts we have are generally about gold, silver, money, etc., most of which are physical instruments. Every individual has different ways and strategies of investing their hard-earned money, either by way of stocks or bonds or by way of simply setting it aside in a savings bank account. However, we fail to consider one important element, which is equivalent to currency, though invisible. Yes, the element is time. Very often the focus is always on the money and how the growth of money helps build up our assets. But what we need to realize is that only when money is invested wisely, over a period of time, leads to its worth being more than what it is today. This brings us to an understanding that our decisions related to investments are influenced by time and funds kept idle give us no returns.
Understanding the Time Value of Money (TVM)
So, what exactly is meant by the “time value of money”? Let us understand the concept of the time value of money a bit more in-depth. Let’s take a simple example – If you have Rs.100 today, you are sure of having much more than Rs.100 in your pocket, after a span of five years. However, this is possible if the money is invested wisely. The right investment of your money will help you have much more than the present value of the money you own. For instance, you could invest this money in equity, debt, bonds, and get some high returns, or you could just let it sit in your bank account for a meager return by way of interest.
Time value of money or TVM is a concept according to which the present value of money is worth a lot more in the future, because of its potential to earn. TVM is also referred to as the present discounted value. TVM has been derived from the idea that an investor would anytime prefer to receive money today than receiving the identical sum in the future, due to the potential earning capacity of money to grow over a certain period of time.
Let us take the example of stock markets. Investing in the stock market would require a bit of research on the sectors and companies that you wish to place your bets on and it involves some amount of risk. If you invest Rs.1 lac in the market in some good blue-chip companies as well as the sectors seeing a move, for instance, a few months back, the Pharma sector saw a surge and any stock held by you in this sector would give you a minimum of 20-30% returns in about 3-6 months. On the contrary, the same amount placed in the savings bank account would give you a minimal return of just 5-6% over a year.
The formula of TVM:
The most fundamental formula of TVM considers the following variables:
FV = The Future value of money
PV = The Present value of money
i = The interest rate
n = The number of compounding periods per year
t = the number of years
Based on the above variables, the formula is:
FV = PV x [ 1 + (i / n) ] (n x t)
Money and Opportunities
Money opens up a lot of opportunities to earn more money, however, every opportunity comes with its set of risks. For instance, investing in the stock market or bonds can be quite risky in contrast to an investment in a fixed deposit. It is crucial to examine every investment option, understand the risk-adjusted returns, and be sure of what you gain and lose in any investment. Also, you must remember that, of all the opportunities that come your way, you can choose just one of these and make the best use of your money in that specific opportunity. When we take advantage of one opportunity, we forego the returns we could earn in another opportunity and this is known as the Opportunity Cost of Money.
How can you make intelligent decisions using the concept of the time value of money?
Firstly, and the most important, would be that your present money must never be kept idle.
Second, look out for various opportunities for investment and choose the one wherein the risk can be handled. Select stocks or bonds or any other investment option where the returns are good and can also preserve the present value. One of the best available options would be that of mutual funds. You could seek professional advice on mutual funds and SIP investment plans which will ensure both the requirements are met. In short, the time value of money is a concept which states that the present value of money is worth a lot more in the future. For example, an investment of Rs.1 lac at present, at the rate of 10% compound interest, for a period of 30 years, would give you about Rs.17.50 lacs!
The time value of money is crucial for every person as it helps in making some wise investment decisions. For example, an investor has the option to select between two projects A and B, both of which have the same descriptions, but Project A promises about Rs.10 lacs cash payout in the first year itself, whereas Project B has the same promise but in a span of 5 years. In case the investor lacks the knowledge of TVM, both the projects would be attractive to the investor. On the other hand, TVM would indicate that the most attractive project is Project A as the payout offered has a higher present value. To sum it up, weigh your options, the returns they offer, and be aware of the time value of money, before investing your money!