Time Value of Money – Money Making Money

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Have you ever wondered how you could purchase 500 yards of land at a price of Rs.1000 per square feet, 20 years ago? Now, can you believe that the value of the same land has increased to Rs.8000 per square ft. This increase in the value of land is not only driven by the strong demographic trends but also because of the time that changed the value of money. Money does not remain static and over a period of time does change in value. The value of money 20 years ago was more when compared to the same amount of money now.

Money has “time-value” attached to it. It is a known fact that money available today is worth more than the same amount of money in future. The reason is not only the effect of inflation, currency devaluation, economic changes but also “the compounding effect of money”.

Compounding of money is nothing but “money making money”. If you have Rs.100 today, and if you invest this money in bank fixed deposit, you earn interest in future. That means, Rs.100 will compound to Rs.109 after a year with an interest of 9%. This interest can further earn interest overtime. This is what is called power of compounding or magic of compounding effect of money. Thus, the effective value of money is strongly dependent on time.

Now, what you do with your money today can make a huge difference in the future. You simply need to deploy your surplus properly. There are many investment avenues, but for getting ahead of others you need to plan for an investment which can bring you returns over time.

Lets take a hypothetical example. Two persons ‘A’ and ‘B’ invest in gold and real estate respectively in 1980. ‘A’ bought 1 tola of gold at a cost of Rs.100 per gram and ‘B’ bought 100 sq yards of land at a cost of Rs.100 per sq ft.

Now in 2011, the value of the gold has increased to Rs.2400 per gram and the value of 1 tola which was bought in 1980 for Rs.1160 is increased to Rs.27,984 which is only 24 times higher, whereas the land which was bought at Rs.90,000 in 1980 is increased to Rs.56,00,000 in 2011. Here the value of land has increased 60 times which is much more when compared to the value of gold.

Although time value of money does not depend on the asset class, but deploying your surplus in a wise investment brings greater returns. So, before investing, think twice and analyse the performance of the asset by understanding the statistics from reliable source. You need to invest in channels that have the ability to gain more returns or income over time.

Also investing early can reap high returns in the long run. Personal finance advises you to understand the time value of money in order to make a right decision of investment at right time. Moreover, selling the asset at right time needs a proper research regularly on the value and performance of the asset.

Thus, by the concept of time value of money with compounding returns, we learn that money value changes over time. This concept does not depend on the asset class but it depends on the interest rates of the investments like fixed deposits, real estates, stocks and bonds. By this we can say that a small investment made early in life can result in a larger account balance in future than a large investment made later in life.