Most Important Concept in Financial Planning: Time Value of Money

How to determine your money purchasing power?

Time value of money (TVM) implies that money received today is always worth more than money received at a later date. It is the basic concept in financial planning. Without this, there is no financial planning.

In other words, money available at the present time is worth more than the same amount in the future due to its potential earning capacity. It is the central financial concept in personal finance. Lets look at this concept from two perspectives below.

time value of money

Financial Value Appreciation

If you receive $ 1,000 today and put it into fixed deposit account with 3 percent risk-free rate of return, your money would have earned $ 30 one year later.

However, if you only receive the same amount one year later, you lose the potential earning capacity of $ 30 as illustrated above.

Financial Value Depreciation

Assume $ 10 could buy you a Big Mac meal last year.

With inflation rate of 3 percent, the very same Big Mac costs $ 10.30 today at your neighbourhood McDonald’s joint. Your very same ten bucks in hand from last year will not be sufficient for the Big Mac meal. Inflation has depreciated your money value by 3 percent.  The value of  ten bucks today is equivalent to $ 9.70 the year before. Do not be confused with the price of Big Mac with the value of your money; they are two different things here. Price is only meaningful when measured against the purchasing power (value) of your money.

The old saying “get the fast buck, not the last buck” nicely captures the time value of money.

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