One of the first lessons I ever learned in finance was the concept of Time Value of Money. It seems appropriate to start my blog off with this, especially as two of my four uni subjects this semester also kicked off with this concept.
The time value of money is the idea that a dollar in today’s money is worth more to you than a dollar received at a future date. This is a pretty important concept because it explains what the true value of any investment you might make is – or the true cost of anything you borrow. Think about it this way. Let’s say your friend Fred has borrowed $100 off you. It’s his shout, he’s run out of cash, and he left his cards at home. He could pay you back via direct debit today, or he could be way too pissed by now to mess with the bank’s app on his phone.
If Fred pays you back straight away, you can use that $100 to make more money, probably by investing in your savings account. Your savings account gives you 5% interest, so in a year’s time you would have $105.
On the other hand, Fred is getting drunk because he’s going overseas for a year. If he’s too hungover to pay you back, he’s still got your original $100. Fred is earning interest on the money that you’ve lent him. At the end of the year, Fred has $105 sitting in his account, but he still only owes you $100. Effectively, by the time the year ends, Fred has $5 of money that he doesn’t deserve for being a broke scab, and you’re $5 out of pocket.
As you can see, Time Value of Money is an important life lesson: It’s in your financial best interest to get paid as quickly as possible, and pay others as slowly as possible (without ruining your credibility as a creditor, of course). Things can get a bit murkier once you start applying this to the real world. The deal with the best face value might not actually be the greatest for you. It’s usually best to either calculate the final value of all the selected options, or ‘discount’ (count back) to a present value. You can also use Effective Annual Interest Rate as a comparison tool, which we’ll cover in another post, along with how to calculate it.
Expedited Knowledge 