1. Time Value of Money
In the poll just before this lesson, I asked you a pretty important
question. Would you rather have $10,000 in your pocket right now or wait
a whole year to get it? This question gives me the opportunity to
actually talk about something that's really important in finance, how money's
value can change over time. This concept is called the time value of
money. Now, I'm not sure what the poll results were, as they get
updated every time a CFI student completes that poll, but
most people would jump at the chance to have the cash today.
And there's some pretty good reasons as to why.
First off, if you wait to get the money later, you're actually putting
off enjoying it today, plus, if you were planning to invest it,
waiting means you miss out on a whole year of potential earnings.
Now, this is what we call the opportunity cost of waiting.
Then there's inflation to think about. Over time, prices tend to go up,
so what you could buy with $10,000 today
might not be the same as in the future.
It's like your buying power shrinks over time. Lastly, there's the risk
that the person who's promising you the money might not come through in
the future. They might not be around or able to pay up. And
this is what we call default risk. The idea that getting money now
is usually better unless you get something extra for waiting is called the
time value of money, or TVM for short. It's a really important concept
in investing because it means money you have today is worth more than
the same amount in the future.
2. Let's practice!