The potential that your money holds now, is more than that of the future. The major reason for this is the inflation, and Opportunity cost also. Every rational investor will prefer getting a sum now, rather than getting a little more in following years, because the Time Value of Money (TVM) is one of the most influential factors in investment decisions. TVM can help you better analyse the interest payments you are going to receive, related risks, and finalise better investment plans.
The authentic TVM definition is that the Present Value of the money you hold now is higher than its expected value in the future, a reason can be that you can earn interest on that if you invest the same.
TVM is directly related to the Purchasing Power of the money holder. Assuming everything else to be constant, inflation decreases the number of goods you can purchase in future, with the same amount of money you have now.
Important Variables that are used to in TVM:
- Present Value- The value of the money you hold now
- Time Period (t)- The timeline of your investment which is usually measured in years
- Annual Compoundings (n)- Depends on how your investment is compounded
- The interest rate (i)- It is the rate at which your money will grow with the time
Let’s assume that you invested 10,000 rupees for 5 years with an interest rate of 10%. The value of this money after 5 years will be
- Rs 16,105.1 if compounded annually
- Rs 16,288.9 if compounded semi annually
- Rs 16,386.1 if compounded quarterly
- And Rs 16,453 if compounded monthly
Annuity is a series of equal cash flows paid or received during a period of time. For example: a car loan or a rent payment. If the cash flows are done at the beginning of the month, they are denoted as Annuity Due and if they are done at the end of the month, they are called Ordinary Annuity.
The Relativistic Time
Expected rate of growth, the present value of investment and the time period for which we are investing are the key factors that can help you to reach an expected future value of your money. But, Markus Peter Auer, professor at University of Innsbruck in his research paper “Stranger Times: The impact of relativistic time concepts on the time value of money” suggested that the relativistic time concept does impact the Future Value of an investment.
The thought emerged from Einstein’s Ideology that according to the theory of relativity’s assumption, time passes differently for two observers. Markus tried to relate this physical theory with the TVM concept. The different time frame in measurement of two TVMs can create biased results, so in order to eliminate the biases, he used the concept of time dilation.
The theory is followed by a lot of assumptions and many other factors were ignored in the report. Markus talked about that too. Keeping track of inertial variables in a multi-market scenario becomes cumbersome for market participants that are situated in a variety of inertial frames. The relativity of time signals towards the problems in valuations and comparison of investment that can emerge due to the time dilation concept, in the investment world.
The Time Dilation is subject to fluctuation which can create difficulties to reach the actual time dilation factor. Things can be simplified if we are able to successfully determine the accurate interest rate which is to be used for the Time Value of Money.