Time value of money is the difference in the buying power of a dollar over time. For
instance, the price of gas was about $2.39 a gallon back in 2020, and today it is averaging
about $4.19 a gallon. Back in 2020, I used TVM by calculating my income minus my
expenses and interest rate of my loan to determine whether or not purchasing a larger
vehicle would be worth the cost. Gas was cheaper and interest rates were lower. So to me,
those factors justified my purchase. Now, fast forward to today and I am regretting my
decision. Now I’m hurting at the pump, at the grocery store, and even on utilities because
of higher energy costs. Inflation, reckless government spending, and a GDP that’s been
negative for the last two quarters all play a large role when it comes to the decreased
purchasing power of the dollar. Thank goodness my interest rates are locked in on my
payment or I’d have to find another thing to sacrifice in order to make the payment. I feel
like everyone is having to make major adjustments just to get by right now. An example of
a situation when I used TVM calculations to support a financial decision was trying to save
money. Deciding what the factors would be in saving. Trying to figure out how much I
should take out of my check every payday to achieve my goal within a certain time frame.
This calculation helped me determine how much to save to reach my goal in 6 months’
time.
The TVM calculations I used to support my financial decision was the formula for
computing the time value of money considers the amount of money, its future value, the
amount it can earn, and the time frame and the benefits this provided. This is what allowed
me to calculate the correct amount and time to reach my goal. In my example I shared, the
cash flow was impacted by a loss. I saved the money I need at a price. I have to cut back in
certain things, such as eating out, buying star bucks, and other items that I would splurge
on. But in the end it was all worth it.We have children and are now in a position,
financially, to discuss saving for their college education. We met with a financial advisor to
discuss our options and how much we need to plan to save.
Our son will be going to college in 16 years. We discussed hypotheticals such as tuition
and fees estimating at $12,000 for the first year, provided that first year would begin in the
year 2038 or 16 years. Compounded for inflation over 15 years what we would need at the
start of year 16. We estimated our inflation rate at 4%.
FV = PV x (1 + g)n
FV = $12,000 x (1 + 4%)15
FV = $21,611.32
Using the future value calculation, we can get an idea of the cost per year with an estimated
inflation rate. We went on to determine how much we would need to save in order to fully
fund their four year college education and the amount was over $80,000. We quickly
realized that we may not be able to fully fund their college education, but rather give them
assistance each year to pay a portion.The time value of money is the concept that the same
amount of money has different values at different points in time. The 100$ in my wallet
today has less purchasing power than the same 100$ I had 2 or 3 years ago because of
inflation. I think that the first time I looked into the idea of TVM was when we got the
mortgage to buy our first home. So when we took out the mortgage to buy our home, the
money we borrowed in a TVM equation is the present value of all the mortgage payments
we were scheduled to pay over the next 30 years. For the $287,000 mortgage for 30 years
at an interest rate of 2.75 percent a year or 0.229% per month. So for the mortgage, we will
have to pay $1852 for the next 360 months. The first cash outflow in this example was our
down payment of 15% from the sale price, then the monthly mortgage payments. Buying a
house can introduce more financial distress than originally meet the eye. For us it was very
important to not only consider the home price at the time of the purchase but also the other
monthly expenses that come along with owning the home. Before we bought the house we
budgeted for the mortgage, and monthly costs like property taxes, home insurance, utilities,
routine maintenance, renovation expenses, and more. We researched each expense and
calculated the debt-to-income ratio to ensure also calculated the debt-to-income ratio to be
certain we can take on this commitment. The time value of money (TVM) means that a sum
is worth more now than the same sum of money in the future. A well-known ancient
parable in the bible mentions a master who gave his three servants different amounts of
talents(money) based on their abilities before taking his long trip. Then, after a long time,
the master returned to settle the accounts with the three servants. a The first and second
servants replied that they had doubled the money through investing, then the master praised
them and awarded them. The third servant fearfully responded that his share had been
hiding in the ground for safety. The master punished him harshly and said: "you ought to
have invested my money to the bankers, and on my return, I would have received what was
my own with interests." This simple example explains clearly the essential concept of
TVM.In my 30 years of insurance career, I have learned about utilizing TVM to optimize
numerous investment results. For example: if I encounter a young couple with two little
children, who wish to have suitable life insurance to protect their family finances, I would,
instead, offer a whole life insurance policy with a much higher monthly premium with
yearly dividends to purchase more amount of life insurance, suggest the couple buy a 30-
year term policy with a much cheaper premium and save the difference to invest into more
aggressive SP500 stocks or other long-term securities because of the historical record of the
growth fund's performance. Another option for the monthly saving is adding a backyard
house for rental income to take advantage of California's new ADU law, which encourages
homeowners to add a backyard unit to boost their revenues and relieve the housing shortage
issues.
