Loading the player...

What is the 'Time Value of Money - TVM'

The time value of money (TVM) is the idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received. TVM is also referred to as present discounted value.

BREAKING DOWN 'Time Value of Money - TVM'

Money deposited in a savings account earns a certain interest rate. Rational investors prefer to receive money today rather than the same amount of money in the future because of money's potential to grow in value over a given period of time. Money earning an interest rate is said to be compounding in value.

Basic Time Value of Money Formula and Example

Depending on the exact situation in question, the TVM formula may change slightly. For example, in the case of annuity or perpetuity payments, the generalized formula has additional or less factors. But in general, the most fundamental TVM formula takes into account the following variables:

FV = Future value of money

PV = Present value of money

i = interest rate

n = number of compounding periods per year

t = number of years

Based on these variables, the formula for TVM is:

FV = PV x (1 + (i / n)) ^ (n x t)

For example, assume a sum of $10,000 is invested for one year at 10% interest. The future value of that money is:

FV = $10,000 x (1 + (10% / 1) ^ (1 x 1) = $11,000

The formula can also be rearranged to find the value of the future sum in present day dollars. For example, the value of $5,000 one year from today, compounded at 7% interest, is:

PV = $5,000 / (1 + (7% / 1) ^ (1 x 1) = $4,673

Effect of Compounding Periods on Future Value

The number of compounding periods can have a drastic effect on the TVM calculations. Taking the $10,000 example above, if the number of compounding periods is increased to quarterly, monthly or daily, the ending future value calculations are:

Quarterly Compounding: FV = $10,000 x (1 + (10% / 4) ^ (4 x 1) = $11,038

Monthly Compounding: FV = $10,000 x (1 + (10% / 12) ^ (12 x 1) = $11,047

Daily Compounding: FV = $10,000 x (1 + (10% / 365) ^ (365 x 1) = $11,052

This shows TVM depends not only on interest rate and time horizon, but how many times the compounding calculations are computed each year.

  1. Compounding

    The ability of an asset to generate earnings, which are then ...
  2. Continuous Compounding

    The process of earning interest on top of interest. The interest ...
  3. Compound Interest

    Compound Interest is interest calculated on the initial principal ...
  4. Discrete Compounding

    Discrete compounding refers to the method by which interest is ...
  5. Effective Annual Interest Rate

    Effective Annual Interest Rate is an investment's annual rate ...
  6. Periodic Interest Rate

    The interest rate charged on a loan or realized on an investment ...
Related Articles
  1. Investing

    Time Value Of Money: Determining Your Future Worth

    Determining monthly contributions to college funds, retirement plans or savings is easy with this calculation.
  2. Investing

    Calculating Future Value

    Future value is the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.
  3. Managing Wealth

    Dissecting the Simple Interest Formula

    Simple interest ignores the effect of compounding: it's only calculated on the principal amount. This makes it easier to calculate than compound interest.
  4. Investing

    Learn Simple and Compound Interest

    Interest is defined as the cost of borrowing money, and depending on how it is calculated, it can be classified as simple interest or compound interest.
  5. Investing

    The Effective Annual Interest Rate

    The effective annual interest rate is a way of restating the annual interest rate so that it takes into account the effects of compounding.
  6. Investing

    Accelerating Returns With Continuous Compounding

    Investopedia explains the natural log and exponential functions used to calculate this value.
  7. Personal Finance

    How Interest Rates Work on Savings Accounts

    Here's what you need to know to grow your rainy-day fund.
  8. Investing

    Overcoming Compounding's Dark Side

    Understanding how money is made and lost over time can help you improve your returns.
  9. Investing

    Understanding the Time Value of Money

    Find out why time really is money by learning to calculate present and future value.
  10. Investing

    4 Ways Simple Interest Is Used In Real Life

    Simple interest works in your favor when you're a borrower, but against you when you're an investor.
  1. Why does time value of money (TVM) assume that a dollar today is worth more than ...

    Learn about time value of money, or TVM, and how a present value calculator is used to determine the value of money received ... Read Answer >>
  2. Why is the time value of money (TVM) an important concept to investors?

    Understand why the time value of money is an important concept for investors. Learn when present value and future value calculations ... Read Answer >>
  3. What formula can I use to calculate interest on interest?

    Find out more about compounding interest, what it measures and how to calculate the amount of compound interest accrued using ... Read Answer >>
  4. How do I use the rule of 72 to calculate continuous compounding?

    Find out why the rule of 72 does not accurately reflect the growth caused by continuous compounding, and which number can ... Read Answer >>
  5. How do I adjust the rule of 72 for higher accuracy?

    Read about the Rule of 72, why it is only an approximation, and how the Rule of 69.3 can be substituted in for more accurate ... Read Answer >>
Hot Definitions
  1. Taxable Income

    Taxable income is described as gross income or adjusted gross income minus any deductions, exemptions or other adjustments ...
  2. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly AIMR) that measures the competence and integrity of financial ...
  3. Initial Coin Offering (ICO)

    An Initial Coin Offering (ICO) is an unregulated means by which funds are raised for a new cryptocurrency venture.
  4. The Bernie Madoff Story

    Bernie Madoff ran a multibillion-dollar Ponzi scheme that is considered the largest financial fraud of all time.
  5. Pyramid Scheme

    An illegal investment scam based on a hierarchical setup. New recruits make up the base of the pyramid and provide the funding, ...
  6. Ponzi Scheme

    A fraudulent investing scam promising high rates of return with little risk to investors. The Ponzi scheme generates returns ...
Trading Center