Coffeetable Blog

I've always gotten quite confused with the term "time value of money". The true essence of the term is sort of hidden in the way it was named. I mean, do you have more time if you have more money? Or rather, would you have more money if you have more time? I know these are semantics, but it helps to introduce a topic that is basic to understanding how to make the most of your time in making more money.

So, what is essentially the money value of time concept? At the heart of it is this: if you can choose when to get your money, you should choose to get it now than tomorrow. Makes sense, right? But why does it makes sense? Primarily because of two things: what that money can buy now will be more than what that same money can buy tomorrow (in short, purchasing power influenced by inflation), and secondly, we can make that money grow by putting it somewhere where the folks will pay us for letting them use it (also known as interest). The first one holds true in most circumstances. The second one deserves a bit more attention.

Note: Not all cultures accept the concept of interest. But even though it's not the way you would choose to earn money, it can still pay to know how it works.

The traditional place to put your money to work is in a bank. The bank takes your money, lends it out, earns an income and splits a portion of it with you in the form of interest. What makes this process very very powerful is the concept of compounding. It simply means that the interest you earned can earn interest too.

How powerful is compounding? An example can make it clear. Suppose two persons have 20 years to save. The first one decided to save 100 per year, for the next ten years at say, ten percent interest. Then he just let the money earn interest from years 11-20. If the other person decides to save at a later date, say from years 11-20 at the same interest rate, how much do you think he would need to put in every year to equal the amount that the other person has at the end of the 20 years? Fifty percent more? Double?

The answer is 1.6 more, or 260 per year. So, the other person saved 1,000 and end up having as much as one who saved 2,600 for the same ten-year period, all because the other person started earlier.

Of course, this is a very simplistic illustration. But it's simplicity makes the concept clearer. We'll build on this topic in future posts. Your comments and questions can help all of us clarify this topic more.