Understanding the Time Value of Money (includes calculator)

By Stock Research Pro • November 7th, 2008

Time value of money is the idea that money available to you right away is worth more to you than that same amount in the future. This is because money has the potential for earning capacity. According to this concept you are better off receiving money right away so you can invest and earn interest on it or use the money to pay down or pay off your debts.

Time value of money describes a core principle of finance that holds that, because money can earn interest, any amount of money is worth more to you the sooner you receive it. This idea is similar to the concept of opportunity cost which says that the cost of any decision must include the cost of the best forgone opportunity.

Understanding Present Value and Future Value

To really understand the time value of money you must be familiar with the idea of present value and future value. Present value is simply the amount of money that you have at the present time while the future value is the amount of money you will have at a given point in the future. You should also be familiar with the power of compounded interest, which is interest earned on top of interest.

For example, if you had $100 and invested it with a 10% compounded interest you would receive $10 on your first interest payment. That $10 dollars would be converted to part of your principal. The interest payment is paid on $110 (instead of just $100) and this very powerful cycle is repeated. Almost all savings and other accounts today offer you compounded interest.

Using the Stock Research Pro Time Value of Money Calculator

(1) Enter the present value (your initial investment)
(2) Enter the interest rate

You may print your results by clicking on the Print button.

Use the Update button any time you make changes to a calculation or click the Reset button to start over with a new calculation.

The calculator demonstrates both the time value of money and the power of compounded interest by displaying your beginning of year and end of year balances and the amount of interest earned in each of the five years of the investment.

Time Value of Money is an important concept in both personal and professional financial management as it can be used to compare various investment opportunities.

More on the time value of money and personal finance


The above information and the associated calculator are educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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