Bias for action. Gets things done. Go-getter. Traits companies big and small look for. And for good reason, you're being hired to do things! However, action is a secondary step that often overshadows the primary step, direction. Clear direction is the foundation that enables our actions to takeoff. Without it, we're stuck in the mud. Striving for clarity is an underrated skill. Having the courage to ask ( seemingly ) obvious questions, and to check in, making sure we're all on the same page. "O bvious " questions are a low risk, high reward way to add value. At worst, you'll add confidence to our actions. At best, you discover a misalignment that saves us from a dead-end. The more people, the more clear we need to be. The bigger the initiative, the bigger the risk of reaching the finish line, only to realize expectations were off. Success is always uncertain. But we can be certain about what we want and what everyone's job is. Things that can be clea
The Time Value of Money (TVM) is the benefit of receiving money now over receiving the same amount later.
A dollar today is worth more than a dollar tomorrow.
This is because of money's potential. It can be invested in the stock market, earn interest in a savings account or used to start a business. The earlier you have money, the earlier you can take advantage of this potential.
TVM Formula
The TVM formula is a great tool to demonstrate this concept. Below are the variables behind TVM.
FV = future value
PV = present value
r = rate of return
n = # of compounding periods per year
t = # of years
The formula can be used to calculate future value:
FV = PV x [ 1 + (r / n) ] ^ (n x t)
This formula can also be re-arranged to calculate present value:
PV = FV/[ 1 + (r / n) ] ^ (n x t)
The TVM formula can be rearranged to calculate any of the above variables, but today we'll focus on present and future value.
Let's take a look at some examples to demonstrate how we can use this formula.
Let's take a look at some examples to demonstrate how we can use this formula.
Example 1 - Jimmy's Future
Jimmy has $1,000, which he plans on investing into a portfolio of index funds for 10 years. Using the future value formula, he can calculate how much his money will be worth after the decade.
Assuming an 8% annual return, the future value of his investment would be:
FV = $1,000 x (1 + (8% / 10) ^ (1 x 10) = $2,158.92
Example 2 - Sarah's Present
Sarah won a bet with her friend Joey. Joey is short on cash right now but agrees to pay her $1,000 in 10 years. Using the present value formula, she can calculate how much her future payment is worth now.
Assuming the same 8% interest, the present value of Sarah's $1,000 prize is only:
PV = $1,000 /(1 + (8% / 10) ^ (1 x 10) = $463.19
Money Now or More Money Later?
It's easy to decide between payment options if the amounts are the same (get paid now!). The present value formula comes in handy when the delayed payment is larger.For example, if Joey offered $400 now or $1000 in 10 years. She should get paid later and choose the $1000.
$400 is lower than the present value of the $1000 ($463.19).
However, if Joey offered Sarah $500 now or $1000 in 10 years. She should get paid now and choose the $500.
$500 is greater than the present value of the $1,000 ($463.19).
Conclusion
TVM is a core principle in finance. It's the reason lenders charge interest on loans and why you expect interest on savings accounts (essentially a loan you're making to the bank). All else equal, money today is better than money tomorrow. It's a simple concept, but essential to financial decision making.
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