CONCEPT OF TIME VALUE OF MONEY

 

TVM ( time value of money ) 

This is a common concept taught in schools, but most students forget it and cannot use it in their day-to-day lives.

Let's break down the concept with this example.

If I have 80 lakh today, I could buy a car, and if I am fortunate, I could save some money and invest in land in the Terai region. But if I had that same amount of money in, let's say, 2015, I could have bought a luxury car and still saved enough money to buy some land in Kathmandu.

From this example, we can easily understand the concept of the Time Value of Money. The value of money does not remain constant, but it fluctuates over time. In many cases, the value of money decreases, but sometimes the value of money increases, depending upon external factors.

So, that was the theoretical approach. Now let's look at the mathematical approach.

If we will receive an amount of 50,000 after 5 years from a bond, and you are required to invest 25,000 in that bond, and the discount rate (required rate of return) is 15%, what is the present value of the bond today?

Before we solve it, we need to understand the concept of the discount rate or required rate of return. It simply means the minimum return an investor requires to make the investment worthwhile. So, the investor discounts the future amount every year by that percentage to account for the changing value of money.

So, we simply have:

Future Value = 50,000

Time = 5 years

Discount Rate = 15%

Present Value = Future Value / (1 + r/100)^years

PV = 50,000 / (1 + 0.15)^5

PV ≈ Rs. 24,858.82

So, you should not invest in this bond because you have to invest Rs. 25,000, but its present value is only Rs. 24,858.82.

This concept is hard for a first-time reader to process. Simply understand that you will receive Rs. 50,000 after five years, but you have to pay Rs. 25,000 today. However, if you had invested that Rs. 25,000 in something else, you could have earned a fixed return of 15%, which becomes your opportunity cost. So, you need to earn at least more than 15% to make a profit.

Now, if we discount the Rs. 50,000 by 15% for the fifth year, then discount that amount by another 15% for the fourth year, and continue this process until the present day, we get the present value. Similarly, by following the same pattern in reverse, we can find the future value if we know the present value.

Understanding TVM helps you:

• Make better investment decisions.

• Compare different financial opportunities.

• Plan for retirement.

• Calculate loan costs.

• Understand interest rates.

• Avoid poor financial decisions.

• Build wealth over time.

Key Takeaways

• Money today is worth more than the same amount in the future.
• Inflation reduces purchasing power.
• Investments help money grow over time.
• Future Value estimates how much money will grow.
• Present Value determines today's worth of future cash.
• The Time Value of Money is a fundamental concept in finance, investing, and business.

Conclusion

The Time Value of Money is one of the foundations of financial literacy. Whether you're saving for retirement, evaluating an investment, or taking out a loan, understanding TVM can help you make smarter financial decisions. The earlier you invest, the more time your money has to grow through the power of compounding, making time one of the most valuable assets in wealth creation.