Welcome to professorsavings.com, we teach finance basics. Today we will teach you about understanding the time value of money.
Hi I’m Rayfil Wong. We hope these investment concepts will help you be a better investor.
The time value of money is a concept that states a dollar today is always worth more than a dollar tomorrow.
Suppose Professor Savings wins $1 million in the lottery today.
Before accepting his price, Professor Savings has to make a decision: he can receive the price money now or if he wants, he can collect the money in one year.
Professor Savings considers his options. If the money is taken today, he can deposit it in an interest bearing savings account at the local bank that offers 10% interest per year.
If he decides not to take the money today, he has to wait a full year with no money and no interest.
Professor Savings is not foolish.
So he decides to take 1 million sooner rather than later.
When the money is withdrawn after a year, it has grown to $1,100,000. By taking the money early, Professor Savings earned an extra $100,000. This is the time value of money as it applies to interest.
$1 million is worth more today because of the possible interest that it earns over the one-year’s time.