Loading the player...

What is the 'Time Value of Money - TVM'

The time value of money (TVM) is the concept that money available at the present time is worth more than the identical sum 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 sometimes referred to as present discounted value.

BREAKING DOWN 'Time Value of Money - TVM'

The time value of money draws from the idea that 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. For example, money deposited into a savings account earns a certain interest rate, and is therefore said to be compounding in value. 

Further illustrating the rational investor's preference, assume you have the option to choose between receiving $10,000 now versus $10,000 in two years. It's reasonable to assume most people would choose the first option. Despite the equal value at time of disbursement, receiving the $10,000 today has more value and utility to the beneficiary than receiving it in the future due to the opportunity costs associated with the wait. Such opportunity costs could include the potential gain on interest were that money received today and held in a savings account for two years.

Basic Time Value of Money Formula

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)

Time Value of Money 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 also on how many times the compounding calculations are computed each year.

RELATED TERMS
  1. Continuous Compounding

    Continuous compounding is the process of calculating interest ...
  2. Cumulative Interest

    Cumulative interest is the sum of all interest payments made ...
  3. Future Value - FV

    Future value (FV) is the value of a current asset at a date to ...
  4. Effective Annual Interest Rate

    The effective annual interest rate is an investment's annual ...
  5. Periodic Interest Rate

    The periodic interest rate is the interest rate charged on a ...
  6. Present Value - PV

    Present value is the current value of a future sum of money or ...
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

    Learn simple and compound interest

    Interest is defined as the cost of borrowing money or the rate paid on a deposit to an investor. Interest can be classified as simple interest or compound interest.
  3. Investing

    Understanding the Power of Compound Interest

    Understanding compound interest is important for both investing and borrowing money.
  4. Investing

    Understanding the Time Value of Money

    Find out why time really is money by learning to calculate present and future value.
  5. IPF - Banking

    How Interest Rates Work on Savings Accounts

    Here's what you need to know to grow your rainy-day fund.
  6. 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.
  7. Investing

    Investing $100 a month in stocks for 30 years

    Find out how you could potentially earn hundreds of thousands of dollars just by investing $100 a month in stocks during your working years.
  8. Retirement

    Compounding Is Important in the Later Years Too

    The power of compounding is even greater in the later years of saving for retirement.
  9. Investing

    How to Avoid the 3 Most Common Investor Pitfalls

    Whether you're about to start investing or are already doing so, avoid these investor pitfalls.
RELATED FAQS
  1. How to calculate compound loan interest in Excel?

    Find out about compound interest and how to use the compounding interest formula in Microsoft Excel to calculate the compound ... Read Answer >>
  2. Continuous compounding versus discrete compounding

    Learn to differentiate between and calculate the continuous and discrete compounding formulas and see how it is going to ... Read Answer >>
  3. Mutual Funds and Compound Interest

    Learn how mutual funds can grow wealth over time through the magic of compound interest by reinvesting dividends back into ... Read Answer >>
  4. What is the formula for calculating net present value (NPV)?

    Net present value (NPV) is a method of determining the current value of all future cash flows generated by a project after ... Read Answer >>
Trading Center