The Time Value of Money and Your Financial Objectives

One well-known fact of economic life is that a dollar received today is worth more than a dollar received a year from now.

Time and Money

The relationship between time and money provides the foundation for virtually every financial decision you will make. Whether you are saving money for a future event or considering a loan to pay for a current financial need, you will be greatly impacted by the time value of money.

This is true for two main reasons. First, a dollar received today can earn interest or appreciate in an investment account, thus increasing it’s value with time. Second, inflation impacts the value of your dollar. As the price of goods increases with time due to inflation, the value (or purchasing power) of your dollar decreases.

Time Value Tips

Whether you are saving for retirement or a down payment on a home, college funding or dependant care needs, you will be greatly impacted by a few simple time value tips.

Time Value Tip #1

The longer you have to prepare, the less your objectives will cost. 

Assuming that you are able to invest your savings and earn a positive return, you will always be better off saving for your goals in advance. Not only will your savings earn interest, but the interest you earn will also begin to earn interest. This is called “compounding” and was referred to by Albert Einstein as the “ninth wonder of the world.”

Time Value Tip #2

The higher the interest rate you are able to secure on your savings, the faster your money will grow. 

Generally speaking, the amount of risk you are willing to take on your investments will determine your long term rate of return. The longer you have to save for your goals, the more risk you should take on your investments, and the greater rate of return you should expect.

Time Value Tip #3

It is usually better to postpone paying taxes on your investment proceeds. 

When you have the choice, you should usually choose to delay paying taxes on investment proceeds as long as possible. This is because as long as you have your investment’s growth in your hands, you can continue to earn more interest on that growth (see “compounding” above.) Once you pay the taxes, you will never earn interest on those lost funds again. One way to postpone the payment of taxes is to invest in “growth” oriented assets, as opposed to interest oriented assets. Another is to use qualified retirement plans whenever possible.

Time Value Tip #4

Factor inflation into your long term plans. 

When preparing for long-term financial objectives, you must factor inflation into your plan. Over the last 20 years, inflation has averaged about 2.23% per year. The cost of some financial objectives will grow even faster than this — college costs, for example, have averaged 6% annual growth. Planning for such cost increases will ensure that your saving level is sufficient to meet your objectives.