The Time Value of Money

A shrewd observer of the laws of physics and economics once said that the two most powerful forces in the world are gravity and the time value of money. It would be hard to argue that point. And, since the time value of money is the foundation of all financial planning, we need to establish a thorough understanding of this powerful concept if we are to achieve financial security throughout life.

There are several elements that can enter into the time value of money -- that magical concept that allows you to quantify your goals in dollar amounts -- including five variables that interact in any given situation, namely:

• present value (PV),
• future value (FV),
• number of compounding periods (N) or sometimes time(T),
• interest rate (I) or sometimes return rate, (R) and
• periodic payment amount (PMT)

Working with these variables and a good financial calculator, or just plain old annuity tables, one can use known factors to determine the unknown quantities through the use of standard formulas.

Financial Calculators This calculator works just like a pocket calculator. And this more advanced calculator computes present value, future value, payments, and/or number of periods.

Moving right along, the basic elements of the time value of money include:

• Compounding -- The magic of compounding!
• Discounting -- The flip side of compounding.
• Inflation -- How much will your dollar erode over time?
• Opportunity Cost -- Choosing one use for your money over another.
• Annuitization -- What to do when you win the lottery.
• Present and Future Value -- Measuring the effects of time.