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. d 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.
