You’ve probably heard that time is money and money is time. Well, you’ve heard it for a reason, because it’s true! In financial circles, there’s a concept called the “time value” of money – this is simply a metric used to measure the worth of money based on different periods of time.
For example, is it more valuable to have $1,000 today or $3,000 in 12 years? To answer that question properly, you need to be able to calculate the future value of $1,000 over a 12-year span.
Future value is a concept worthy of examination in and of itself: allow me to demonstrate.
We’ll use our trusty example of $1,000 now vs. $3,000 in 12 years. In this instance, let’s assume that you expect to make 8% on your investments. Warning: this part involves math, but don’t worry, it’s easier than it looks.
Figuring out Future Value (FV):
Equation: FV = Original Amount x (1+interest rate)Time
Let’s plug in our numbers.
FV = $1,000 x (1 + 0.08) 12
We arrive at an FV of $2,518.17 in twelve years.
It’s clear to see that with a return of 8% on our investments, $1,000 now would be less valuable than $3,000 in 12 years.
Just as money has a future value, it also has a present value – and I’m not talking about the ones you get for Christmas. Present value is another way of solving our $1,000/$3,000 dilemma, and it’s pretty handy. It’s basically the reverse of our last equation, and is used to figure out how much the $3,000 in 12 years be worth now.
We’ll use a different example to make this equation as easy as possible.
Let’s imagine you were going to receive $5,000 in 5 years. Woohoo! But what would it be worth now? Let’s use an interest rate of 7%, just because.
Figuring out Present Value (PV)
Equation: PV = FV / (1+interest rate) Time
Let’s plug in our numbers.
PV = $5,000 / (1 + 0.07) 5
We arrive at a PV of $3,564.93
So, to put this another way, $3,564.93 today would have the same value as $5,000 in 5 years, assuming the interest rate is 7%. See – it’s simple!
Remember, calculators and spreadsheets can make these equations even easier, so don’t be intimidated by all the numbers.
Now that you’re armed with these equations, let’s see what you can do with them. You could start by calculating the amount your investments and savings account will be worth in a couple of years – this can tell you a lot about how worthwhile these endeavours are.
Let’s suppose you want to be a millionaire in 25 years (who wouldn’t want that?). Using the above equations, you can calculate how much money you’ll need now to ensure you reach that target within the timeframe. You could even look into the amount of money required to reach your target sooner.
I’ve compiled a quick list of the most common situations in which these calculations can prove useful:
– Student Loans
– Savings Accounts
– Credit Cards
– Mortgage Payments
– Retirement Planning
Of these aspects, our equations are probably most commonly applied to retirement planning. Perhaps that’s because older people have the good sense to do their math! Try playing with a few examples from your own life. Figure out how much your current savings will be worth in the future; investigate the future value of all of your retirement investments. It can be quite a gratifying activity!
However you go about using these equations, you’re now equipped to calculate exactly what time is financially worth to you. Applying these simple but powerful concepts will make financial decisions a hell of a lot easier, and you’ll feel like a mathematical genius whilst you’re at it.
Enjoy and feel free to share it with your friends!