Time Value of Money
BeginnerThe time value of money is the idea that money available today is worth more than the same amount received in the future, because money today can be invested to earn a return.
If someone offers you 1,000 today or 1,000 in one year, taking it today is better. You could put it in an account paying 5% and have 1,050 in a year. Waiting means giving up that 50, so the future 1,000 is worth less to you than the present 1,000.
There are three reasons money today is more valuable. It can earn interest or returns. Inflation may reduce what money buys in the future. And future payments are less certain: something could happen before they arrive.
The time value of money works in two directions. Moving money forward in time, by adding interest, gives its future value. Moving future money back to today, by removing the interest it could have earned, gives its present value. This second process is called discounting.
This idea is the foundation of almost all of finance. It explains why loans charge interest, how bonds and shares are valued, how businesses decide which projects to invest in and why starting to save early makes such a big difference.
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