Introduction: What is time value of money?
Time value of money (TVM) is the idea that money that is available at the present time is worth more than the same amount in the future, due to its potential earning capacity. This core principle of finance holds that provided money can earn interest, any amount of money is worth more the sooner it is received. One of the most fundamental concepts in finance is that money has a time value attached to it. In simpler terms, it would be safe to say that a dollar was worth more yesterday than today and a dollar today is worth more than a dollar tomorrow.
This chapter is a practical approach to the time value of money. We fully understand that today's technology provides multiple calculators and applications to help you derive both present value and future value of money. If you do not take the time to comprehend how these calculations are derived, you may make critical financial decisions using inaccurate data (because you may not be able to recognize whether the answers are correct or incorrect). There are five (5) variables that you need to know:
- Present value (PV) - This is your current starting amount. It is the money you have in your hand at the present time, your initial investment for your future.
- Future value (FV) - This is your ending amount at a point in time in the future. It should be worth more than the present value, provided it is earning interest and growing over time.
- The number of periods (N) - This is the timeline for your investment (or debts). It is usually measured in years, but it could be any scale of time such as quarterly, monthly, or even daily.
- Interest rate (I) - This is the growth rate of your money over the lifetime of the investment. It is stated in a percentage value, such as 8% or .08.
- Payment amount (PMT) - These are a series of equal, evenly-spaced cash flows.
You can calculate the fifth variable if you are given any four of the five (all) variables listed above. A simple example of this would be: If you invest one dollar (PV) for one year (N) at 6% (I), you will receive $1.06 (FV). This would be the same as saying the present value of $1.06 you expect to receive in one year, is only $1.00 (PV).
To understand the time value of money successfully, let's learn step by step throughout the five chapters below.
Chapter 1. Interest rates - types and terminology
Chapter 3. What is amortization?
Chapter 4. TVM impact on debts
Chapter 5. TVM impact on investments
This was made possible in partnership with The Singleton Foundation for Financial Literacy and Entrepreneurship. This video and more videos like this can be found on Millionstories.com.