TIME VALUE OF MONEY
- Some people put their money in a bank account; some make investments in stocks and bonds.
- Different people follow different strategies to keep their money on the move.
- All of them consciously or unconsciously realize time is the biggest enemy of idle money.
- But what makes a rupee in our hands today worth more than a rupee tomorrow?
- What is so different about currencies made of paper that the value of the same amount of money diminishes with time….?
- So, the concept of time value of money always influences our decision about what we intend to do with our money.
Well…
- You need not be a philosopher to understand the concept of time value of money.
- A ₹2000 note today in our pocket is worth more than a ₹2000 note that we may get after five years. All of us intuitively know that.
- But let’s try to understand what actually makes the present value of money worth more than the value of the same amount of money after five years.
Remember…
- Money is just another name for new opportunities.
- The money that you have now can open the doors for many opportunities. Different uses of money may have different advantages.
- Some of these opportunities may look very small but some of them might really put you on the fastest track to the future.
Here’s a new term for you to know!
- If you invest your money now, you would earn a return which would make your money grow in the next five years.
- But the problem is you can choose only one of the many equally advantageous opportunities. All of us try to use our money for the best possible opportunity.
- The advantage that we forego by not putting our money in another possible opportunity is what is called the Opportunity Cost of Money.
For example…
- So, if you are investing your money in a 10 year bond that pays you 9% interest, then you are foregoing an opportunity of putting the same money in a 10 year term deposit that pays you 7% interest.
- In this case, your actual advantage is only the 2 percentage points more interest that you earn on your investment in bonds.
- But always remember that different opportunities have different risks. Investment in bonds may be riskier than investment in term deposits.
- So you should always compare the risk adjusted return to find out whether you are gaining or losing in making a particular use of money.
It is better to eat your breakfast before inflation eats your money!
- Today you can buy two pizza’s for ₹300, but maybe after five years you would be able to buy only one with the same amount.
- So you have to think if I give you an option of either taking two pizza’s today or one pizza after five years, which option would you choose…?
How can you use the concept of time value of money to make intelligent decisions about your money…?
- The first thing you must keep in mind is that you should never keep your present money idle.
- Money has to grow with time. Invest it in stocks or bonds so that the return is good enough to at least preserve its present value.
- And still better, take the mutual funds route to take advantage of professional fund management services.
To Sum Up
- If you invest Rs. 5 lakhs now, what should its worth be after 30 years if you are earning 10% return per annum compounded annually?
- For your knowledge, let me tell you that Rs. 5 lakhs would be worth Rs. 87.24 lakhs after 30 years. Almost appreciated by 16 times.
- The concept of time value of money says that the value of money at present is worth more than the same amount of money in the future.
By making appropriate investment decisions, we can make money grow with the passage of time.
