DescriptionThe value of money is sensitive to the passage of time, meaning a dollar received today is more valuable than a dollar received a year from now. This is because of investment opportunity and inflation. The return that can be garnered from that dollar will be based on what investment opportunities exist and the rate of return that can be generated. Another consideration is investment risk. An investor seeking the possibility of a greater return will need to acquire riskier investments. Money also can lose some of its true value over time because of inflation, as the prices of most goods increase, decreasing the buying power of the dollar. The time value of money varies based on how these inputs change.
At A Glance
- An important principle of finance is that the value of money is sensitive to the passage of time. Its amount and earning capacity in the present time is worth more than the same amount in the future.
- Time value of money is the driving force behind investing and economic trading.
- The time value of a dollar can change based upon several inputs, such as the annual percentage rate or compound interest.
- Making sound investment decisions depends on a strong understanding of the future value of money.
- Understanding the comparison between present and future values of money using mathematical tools is central to investment decision-making.
- The future or present value of money can be calculated given the variables of the number of periods (time), interest or discount rates, the amount invested, or the future value of money.
- The annual payout of an annuity can be calculated as long as the principal and interest rate are known.
- Investors can use financial calculators to perform various financial calculations. These calculations can also be done easily using spreadsheets.
- The most indicative input to the time value of money is inflation, which impacts purchasing power and investing.
- Demand-pull inflation and cost-push inflation can cause elevated price levels in a product or service and increase the velocity of money.
- The historical timeline of finance is full of examples of economic cycles of high inflation and recession.