Posted in Triplett & Carothers on February 3, 2025
Although it seems to go against the grain, you might be better off cashing in sooner rather than later. Investors and consumers alike need to understand the concept of time in relation to the value of money. Basically, a sum of money today is worth more than it will be tomorrow, next month or next year.
Money, like other commodities, has a cost and a price, both of which are largely reflected in prevailing interest rates. These concepts were explored in the 16th century by Martín de Azpilcueta, a Spanish theologian and economist.
A bird in the hand is worth two in the bush
Even without delving deep into mathematical formulas, we can see — in simple terms — why money should represent a higher value today than it does later on. There are three main reasons the worth of money may erode with each passing hour.
First, consider the opportunity cost while remembering that cash can be spent, invested or grown. A dollar today has a value that differs from the same dollar next year because the dollar will generate interest during the interim.
Compounding amplifies this effect. But if you leave your money alone, in your sock drawer or under the mattress, it will not yield any returns. This means you have forgone a precious opportunity. At the end, you will hold the same piece of green paper you started with.
The second reason is inflation, which bites the hardest when you’re not paying attention. With each passing day, you are losing purchasing power, especially when it is running rampant. For instance, a bag of groceries will likely cost you more in a year’s time.
The third reason is plain uncertainty. Something unexpected could go horribly wrong with your money before it circles back. That’s why, in order to analyze the full value of your dollar, you’ll need to translate it into future value.
In other words, ask yourself how much an entire cash flow received today will be worth later. Alternatively, you could flip that concept inside out and calculate how much you would need in current dollars to yield a specific sum.
Make better decisions
A tool that calculates the time value of money can help investors and managers make the most profitable decisions. If you luck out and win money from a lottery, you might need to choose between a lump sum right now or a stream of annual payments. Hint: Take it and run.
Consumers often wonder whether it’s better to put money down on a car or another big-ticket item rather than finance an expensive purchase. Alternatively, should you increase your retirement contributions instead? The options seem endless.
However, many retirement vehicles base their payouts on the time value of money, such as pension funds, 401(k) plans, IRAs and annuities. Likewise, Social Security recipients must elect when it would be most optimal for them to start receiving benefits.
Suppose you are contemplating a new job offer. Will your compensation include stock options or bonuses involving election decisions?
In another case, imagine a real estate developer extends you a vacant lot for $100,000. The developer also offers you a guarantee that he or she will repurchase it in a decade for $250,000. Is that 9.6% rate of return viable enough for you to accept the deal? You might also need to decide on mortgage payment options or charitable donations.
You can use formulas based on present value, interest rates and the number of compounding periods. You can also simplify the process of calculations by applying the formula in Excel or Google Sheets.
Use your time wisely
The old “time is money” platitude was first expressed in 1748 by Benjamin Franklin in his essay “Advice to a Young Tradesman, Written by an Old One.” He examined the cost of lost time lazing around instead of exchanging labor for wages.
Yet labor is not always the counterpart to leisure. Some experiences cannot be postponed. Instead, it’s better to define your priorities and spend your ”currency” of time on meaningful activities. Strike a balance, and use time management for efficiency.
Franklin would also suggest you avoid frivolous and needless spending. Your financial adviser can help you build your portfolio. Don’t forget to keep an eye on ways you can put your funds to work ASAP for the ultimate impact.