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. Annualized Total Return

    The average amount of money earned by an investment each year ...
  3. Compound Interest

    Compound Interest is interest calculated on the initial principal ...
  4. Present Value Of An Annuity

    The current value of a set of cash flows in the future, given ...
  5. Future Value Of An Annuity

    The value of a group of payments at a specified date in the future. ...
  6. Future Value - FV

    The value of an asset or cash at a specified date in the future ...
Related Articles
  1. 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.
  2. 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.
  3. Investing

    Time Value Of Money: Determining Your Future Worth

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

    Learn Simple And Compound Interest

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

    Calculating the Present Value of an Annuity

    The present value of an annuity is the current, lump sum value of periodic future payments as calculated using a specific rate.
  6. Personal Finance

    How Interest Rates Work on Savings Accounts

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

    Investing $100 a Month in Stocks for 20 Years

    Learn how a monthly investment of just $100 can help build a future nest egg using properly diversified stocks or stock mutual funds.
  8. Investing

    Why Leveraged Investments Sink

    This powerful tool can have you swimming in money or drowning in underwater equity.
  9. Retirement

    Are You On Track To Hit Your Desired Net Worth By Retirement?

    Here are some calculations to determine if your net worth is what it should be at your age.
  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. 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 >>
  4. 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 >>
  5. What is the formula for calculating net present value (NPV)?

    Learn about the formula for net present value (NPV) and how this calculation is used in capital budgeting to determine which ... Read Answer >>
Hot Definitions
  1. Smart Home

    A convenient home setup where appliances and devices can be automatically controlled remotely from anywhere in the world ...
  2. Efficient Frontier

    A set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a ...
  3. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  4. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the ...
  5. Border Adjustment Tax

    A tax levied on goods based on where they are sold – exported goods are exempt from tax; those imported and sold in the ...
  6. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
Trading Center