Understanding the Time Value of Money

Your dollar today may not be equal to the dollar you have a few years from now. That is why there is a financial term called the time value of money. Time changes what your money is worth. Because of this, you have to balance several factors when you are planning to invest or save. These factors include interest and inflation. Note that while you can invest at a fixed interest, you have no hold on inflation.

Importance of money’s time value

Time value of money is the basic principle behind many important and popular financial concepts. When you talk about simple and compound interest, you have to keep money’s time value in mind. Because of the possibility of inflation, you may actually profit through paying on an installment basis. This depends on the interest rate of course. If your total payments exceed the future value of the original price, you may have lost in the bargain. However, if you are paying $20,000 after interest for a product worth $17,000, you may still be at the winning end if the present value of that future $20,000 payment is $17,000.

Calculating time value with a financial calculator

Before using your financial calculator, you must thoroughly understand the problem you are set out to solve. Make sure that the calculator is cleared before input anything. Other things you should input are: number of compounding periods in a year, annual interest rate and the number of compounding periods in total. Remember to put a negative sign before numbers that are representative of outgoing money.