Money available today can be saved, invested or spent. Understanding the time value of money can help you compare money received at different points in time and make more informed decisions about saving, investing, borrowing and retirement.
What is the time value of money?
Would you rather receive CHF 1’000 today or CHF 1’000 in ten years?
At first, the answer may seem obvious: they are both CHF 1’000. But they are not necessarily financially equivalent.
A franc available today can be saved or invested and may generate a return. Over time, those returns can potentially generate further returns through compounding. Inflation can also reduce what the same nominal amount can buy in the future.
This is the time value of money (TVM): the principle that a given amount of money available today is generally worth more than the same nominal amount received in the future, assuming money available today has the opportunity to earn a positive return.
Three ideas help explain why.
Money today has the opportunity to grow
If CHF 1’000 earns a hypothetical 5% annual return, it would become CHF 1’050 after one year. If the return were earned again in the second year, it would be calculated on CHF 1’050 rather than only on the original CHF 1’000.
That is compound growth.
Inflation can reduce purchasing power
Prices tend to change over time. When prices rise, the same amount of money buys fewer goods and services.
If an item costs CHF 1’000 today, it may cost more in ten years. The future CHF 1’000 therefore may not have the same purchasing power as CHF 1’000 today.
Future payments involve uncertainty
Money already available to you is known. A future payment may depend on a contract, an institution, a counterparty or other circumstances.
The degree of uncertainty varies considerably, but it can be relevant when comparing cash flows received at different times.
“The time value of money is not simply about how much money you receive. It is also about when you receive it.”
How does compounding affect the future value of money?
Compounding is where the time value of money becomes especially powerful.
Imagine CHF 1’000 invested at a hypothetical 5% annual return, with all gains reinvested.
| Time | Illustrative value |
|---|---|
| Today | CHF 1’000 |
| 1 year | CHF 1’050 |
| 5 years | CHF 1’276 |
| 10 years | CHF 1’629 |
| 20 years | CHF 2’653 |
| 30 years | CHF 4’322 |
During the first few years, the increase may appear modest. Over longer periods, however, previous gains can themselves participate in future gains.
The calculation is:
Future value = Present value × (1 + return)^number of periods
The example assumes a constant annual return and no withdrawals, fees or taxes. Real investment returns fluctuate and can be negative.
Why does starting earlier matter?
Time cannot guarantee an investment return, but it determines how long capital has the opportunity to compound.
Consider two people who each invest the same CHF 1’000 at the same hypothetical 5% annual return. One invests today. The other waits 20 years.
The person who starts today gives the original investment an additional 20 years in which returns can potentially generate further returns.
This does not mean everyone should invest immediately. Emergency savings, short-term financial needs, investment objectives and risk tolerance all matter.
The lesson is narrower: waiting has an opportunity cost.
Once someone is financially ready to invest, starting earlier can give their capital more time to work.
What is the future value of money?
Future value of money describes what an amount available today could become at a specified point in the future, based on an assumed rate of growth.
For example, CHF 1’000 growing at a hypothetical 5% annually would become approximately:
- CHF 1’629 after 10 years
- CHF 2’653 after 20 years
- CHF 4’322 after 30 years
Future value can be useful when estimating how today's savings might contribute towards a future objective.
But the result is only as meaningful as the assumptions behind it. A calculation based on a constant 5% return is an illustration, not a forecast.
Changes in market returns, interest rates, fees, taxes and inflation can all affect the actual outcome.
What is the present value of money?
Present value of money works in the opposite direction.
Instead of asking what today's money might become in the future, present value asks:
“If I expect to receive money in the future, what is that future cash flow worth today?”
To answer this, the future amount is discounted using an appropriate discount rate.
For a single future cash flow, the relationship can be expressed as:
Present value = Future value ÷ (1 + discount rate)^number of periods
Suppose CHF 1’000 is due in ten years.
At a hypothetical 2% annual discount rate, its present value is approximately CHF 820.
At a hypothetical 5% annual discount rate, its present value is approximately CHF 614.
The higher the discount rate, all else being equal, the lower the present value of the future payment.
A discount rate can reflect the return available on alternative uses of money and the risk associated with the cash flow. Inflation may also be relevant depending on whether the calculation is being made in nominal or real terms.
How does inflation affect the time value of money?
Inflation is important because financial values expressed in francs do not necessarily tell you how much those francs will buy.
If prices rise by an average of 2.5% per year, for example, the purchasing power of a fixed CHF 1’000 amount would decline over time.
This distinction is the difference between nominal value and real value.
Nominal value tells you the number of francs.
Real value considers what those francs can actually buy.
For long-term planning, particularly retirement planning, ignoring inflation can make a future amount appear more valuable than it may be in purchasing-power terms.
Shows what money available today could become in the future under a stated growth assumption.
Translates a future cash flow into an equivalent value today using a discount rate.
Shows why the same nominal amount may buy a different quantity of goods and services over time.
What are some time value of money examples in everyday life?
The time value of money examples below show why TVM is not limited to financial textbooks. It appears whenever money is received or paid at different points in time.
Pension choices
A retirement decision may involve comparing regular future pension payments with a lump-sum payment.
The nominal totals alone do not necessarily tell you which alternative is more valuable. Timing, longevity, investment assumptions, taxes and personal circumstances can all matter.
Bonuses and deferred compensation
CHF 10’000 paid today is not financially identical to CHF 10’000 paid several years from now.
A deferred payment may therefore need to be discounted before it can be compared meaningfully with an immediate payment.
Property decisions
Owning a property may produce future rental income, while selling it may produce a larger amount immediately.
Comparing the alternatives involves considering the amount and timing of future cash flows, as well as costs, taxes, risks and other assumptions.
Long-term agreements
Mortgages, leases, annuities and other long-term agreements all involve payments distributed across time.
TVM provides a framework for comparing those cash flows on a more consistent basis.
How does the time value of money affect borrowing?
Borrowing reverses the perspective.
A borrower receives money today and agrees to repay it in the future, generally with interest.
The longer a balance remains outstanding and the higher the applicable interest rate, the greater the potential total cost.
For example, as a purely mathematical illustration, CHF 1’000 growing at 12% per year would reach approximately CHF 9’646 after 20 years if interest were compounded annually and nothing were repaid.
Real loans and credit-card balances are governed by their own rates, repayment schedules, fees and contractual conditions. The example simply illustrates how strongly interest and time can interact.
Before borrowing, useful questions include:
- How much will I repay in total?
- How long will I be making payments?
- Is the interest rate fixed or variable?
- What fees apply?
- How would a longer repayment period affect the total cost?
Why does longevity make the time value of money more important?
Longer lives can mean longer retirements.
That changes retirement planning from a question of simply accumulating a target amount into a broader question:
“How can my financial resources support my spending needs throughout retirement?”
The timing of pension income, investment withdrawals and other cash flows becomes particularly important when those resources may need to last for several decades.
Inflation also matters because retirement spending occurs in the future. A retirement budget expressed in today's francs may not purchase the same goods and services 20 or 30 years from now.
No one can know exactly how long they will live or what future inflation and investment returns will be.
A retirement plan can therefore be more useful when it considers a range of assumptions rather than relying on a single forecast.
What is the cost of waiting to save or invest?
Waiting has two potential costs.
The first is obvious: the contributions that were not made.
The second is less visible: those missing contributions also lose the opportunity to generate returns and potentially compound.
Imagine one person invests CHF 1’000 at age 25 and another invests the same CHF 1’000 at age 35.
If both investments subsequently experience the same return, the first amount has had an additional ten years of potential growth.
Additional contributions later can increase the amount invested.
What they cannot do is recreate elapsed time.
This is why the time horizon is an important part of long-term financial planning, alongside the amount saved, expected return, risk, fees, taxes and inflation.
What tools can help you understand the time value of money?
You do not need to calculate every scenario manually. Several simple tools can make the effects of time easier to see.
Compound interest calculator
Shows how an initial amount or regular contributions could grow under different hypothetical rates and time horizons.
Future value calculator
Estimates what an amount today could become at a future date based on specified assumptions.
Present value calculator
Discounts a future cash flow to estimate its equivalent value today.
Inflation calculator
Illustrates how changes in prices can affect purchasing power over time.
These tools do not predict the future. Their value is in helping you understand how different assumptions change an outcome.
The time value of money is ultimately about choices made across time.
Money available today can potentially be saved, invested or spent. Money received later cannot be used today. Compounding can increase the future value of capital, while inflation can reduce purchasing power. Present value allows future cash flows to be compared in today's terms.
None of these concepts can predict investment returns, inflation or how long someone will live.
What they can do is provide a framework for asking better questions.
How much? When? At what rate? For how long?
Understanding those four questions can make decisions about saving, investing, borrowing and retirement considerably clearer.
The earlier you understand that time itself has financial value, the better equipped you are to make deliberate choices about your financial future.
Disclaimer
The content in this article is provided for educational purposes only. It does not constitute investment advice, financial recommendations or a guarantee of future results.
Frequently asked questions
What is the time value of money in simple terms?
The time value of money is the principle that a given amount of money available today is generally worth more than the same nominal amount received in the future when today's money has the opportunity to earn a positive return. Inflation and uncertainty can also affect comparisons between cash flows at different times.
What is the difference between future value of money and present value of money?
Future value of money estimates what an amount today could become in the future. Present value of money works backwards, estimating what a future cash flow is worth today after applying an appropriate discount rate.
How does compound interest affect the time value of money?
Compound interest allows returns to generate additional returns when they remain invested. The longer compounding continues, the greater its potential effect, although investment returns are not guaranteed and can be negative.
What are practical time value of money examples?
Common time value of money examples include comparing a lump-sum pension with future payments, evaluating deferred compensation, calculating the cost of a loan and estimating how much today's savings might be worth at retirement.
Why does inflation matter when comparing money today and money in the future?
Inflation can reduce purchasing power. Even if a future payment has the same nominal value as an amount today, it may buy fewer goods and services if prices have risen in the meantime.
Le contenu de cet article est fourni à des fins éducatives et de marketing uniquement. Il ne constitue pas des conseils d’investissement ou des recommandations financières.
