Economic Time Preference: How Much Do We Value Time?

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"Time is money" - this is one of the oldest sayings in the world. Interestingly, it is true. There is a value attached to our time and it is not the same for everybody. The same goes for money. A $100 bill has different values at different times. A dollar today isn't the same as a dollar tomorrow. This is why it is very important that you understand the time value of money as well as the risk and return of money. This knowledge will greatly improve your personal and professional finances.

In Economics 101, you learned that money that is available at the present time is worth more than the same amount in the future. The idea behind this is that the money at hand has more earning capacity than the same amount in the future. Take for instance, would you rather take $10,000 today or wait for the next two years to receive the same amount? For any rational thinking person, it makes more sense to take the money today. With the right investment, that money could bring many returns in two years. This underlines the fundamental concept in finance that money has a time value attached to it.

Understanding the Time Value of Money

Consider this scenario: You have a $10,000 bill to pay. As it turns out, you have $40,000 in your personal account. Paying this $10,000 bill won't affect your day-to-day living significantly. However, you have an option to postpone this payment to the next 4 years.

Would you rather pay this bill today or wait for 4 years to pay it? If you choose to pay it immediately, that is a smart choice. If you choose to wait for 4 years, this means you are paying more than $10,000. The value of money would be affected by inflation. It is a simple logic, what $10,000 can buy today, it cannot buy tomorrow. This is the reason why your rent keeps increasing year-after-year. Inflation plays a great role in the value of money across time.

The time value of money varies and involves an opportunity. Simply put, the opportunity cost is a term that explains the sacrifices you make in order to gain something else. If you choose to invest $1000 in a stock today instead of buying the latest smartphone, the foregone smartphone is your opportunity cost. You made this sacrifice with the hope that in a couple of years, your stock would have increased and returned a profit.

The time value of money is based on the concept that rational people would rather have money today than in the future and investment(risk) will have a return over time. Since investment can earn compound interest, it is therefore considered more valuable to make an investment today than wait until later in the future.

There is no doubt that understanding the time value of money will help you make smart financial decisions.

Should You Invest Today or Pay Off Your Debt First?

The value of money comes into play when solving the debt vs. investment dilemma. Most people run into various types of debt over time. This includes credit card debts, or loans to buy a car, buy a house, or pay college tuition. Whatever the reason, debts come with interest which can increase the amount you pay back. These interests compound the longer you wait to pay off debt.

The same goes for investment. Making an investment is not the same as saving money. When you make an investment, you expect a return in the form of dividends, interests, or through the appreciation of the investment product.

Most people usually face a dilemma when faced with debt vs. investment decisions. Perhaps, one of the best ways to make a decision in this scenario is by calculating the value of money over time. You should take the present value, the net value, the future value, inflation, as well as compound interest into consideration.

Calculating Time Value of Money

When faced with the sort of dilemma mentioned above, the smart thing to do is to resort to basic mathematics. This will ensure you make an optimal decision. When you calculate the time value of money, it is possible to discover that making an investment today will bring enough return to pay off your debts in a couple of months. Additionally, it may make more sense to pay off debt than to invest. One of the scientific ways to make this decision is to use the "TVM Formula" also known as the time value of money formula.

The TVM formula allows you to determine the value of money over a period of time. This is done using:

• Present Value (PV)
• Future Value (FV)
• Interest Rate (IR)
• Number of periods
• Payment

The formula is given below as:

PV=FV×(1+i) ⁻ⁿ

 where:

• PV=Present value (the original amount of money)
• FV=Future value
• i=Interest rate per period
• n=Number of periods

Time Value of Money Calculator

Fortunately, you do not need to be a math genius to use this formula. You do not even need to understand the formula, thanks to the presence of time value of money calculators. Such a calculator allows you to simply plug in the values, decide what you want to compute for, press "Calculate" and get your answers in less than a minute. Therefore, we recommend using a TVM calculator when making both personal and professional financial decisions to explore all possible scenarios. This will ensure you get values you can trust without hassle.

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