The Time Value of Money Defined

You always hear that it takes money to make money right?  Well that’s not always the case –   Plenty of successful people have bootstrapped their way to success, starting with nothing but a positive attitude and a willingness to work harder than everyone else – but it is true that having some money does make it easier to make more money.

Time Value of Money Why is that?  Simply put, it’s compounded interest.  Investing.  The Time Value of Money.

We’ll explain what that means and how important it is in this post.

Wealthy People Invest Their Money

One thing that almost everyone you would consider financially healthy (or rich) have in common – and the one takeaway I hope you get from reading this – is that they put their money to work for them.  They use it to buy something that appreciates in value – that’s the definition (at least MY definition) of investing, and it’s all based on the time value of money.

A house. Stocks and Bonds (for now, at least). Art. Guitars. Guns (actually a great investment, fyi, and a fun one). And so on.

As long as the value increases more than inflation, you’re making money without doing anything.  You’re not slaving away behind cubicle walls developing carpal tunnel syndrome and ruining your eyesight from staring at a computer screen trying to sell more widgets from 8-5 every weekday for this money.

Wealthy people understand this, and anyone that wants to build a better lifestyle should understand it.  It’s how you generate freedom. It’s also why saving money and having a good budget is so important, because you need that starting money so that you can use it to make more.

Time Value of Money Defined

If you need some motivation, take a look at the graph above.  It’s kind of the standard “retirement planning” graph depicting the time value of money and the principle of compounded interest.

Let’s say you start investing now at a rate of $1000 per month.  The different lines on the graph represent different rates of return.  The blue line shows the money you’ve actually invested.  And what you would have if you made 0% interest on that money.

If all you do is call up a stockbroker and have them take care of everything, assuming the market stays somewhat near its long term trend, you’ll make at least 6%, though I think the long term average is closer to 8% in reality.

Now 6% may not sound like much – you may not think it’s worth the effort.  After all, in the first year, you’ve invested $12000.  Making 6% only boosts that $12k up to $12720.  Not life altering, I’ll admit.

Compounded Interest Defined

The magic starts to happen when you compound that interest, meaning that you don’t only make that 6% interest on the $12,000 you invested, but on the whole $12720.

This is also what nerds like me would call exponential growth.  It’s an accelerating growth curve.  Instead of increasing the same amount each year, the amount that it increases is also growing each year.

Now take a look at the data point at 30 years. The blue line is how much money you have if you don’t invest – around $400,000.  The green line is what you would have if you made the market average – around $1.5 Million. 

Not bad for very little effort.  Now I understand that $1.5M may not be worth quite as much in 30 years.  I also understand that there are other things you can do with your money that will provide a better rate of return – like starting a business and investing in that. But all I’m trying to convince you of here is that the small amount of effort it will take now to start investing will really make a difference down the road.  Who wouldn’t want an extra couple million dollars when they retire?

The Takeaway – Start Investing Now!

Don’t let your money sit idle in a checking / savings account earning 0.5% interest.  Do something with it.  Start a collection.  Buy some stocks.  Get into your company’s 401k if you have one.  Just don’t let it sit around collecting dust.

I like to try to give some practical action items here so that you can start benefiting from this information right away, so here is the quick 10 second guide – the minimum you need to know to start right now.

Option 1: Stock Broker

Call a professional.  Do a quick google search and pick a reputable one.  Ask them how to get started investing.  In a half an hour they’ll have an initial plan set up for you.  You’re not stuck with them forever, so don’t worry too much.  Just do it.

Option 2: Online Broker

TD Ameritrade, eTrade, any of the like are good options if you want to save money on commissions and do it yourself.  Pick one, sign up and deposit money – you probably need $500-$1000 to start.  Then pick a stock from a company you think will be around forever and buy some shares.  Simple as that.

The first step can be the hardest sometimes, but I find the best way can be to jump right in and learn as you go.  You’ll pick things up quickly, and you may make some mistakes, but it’s much better than over analyzing, trying to make things perfect and then never doing anything.

What Better Time than Now

The most important part of the time value of money is the TIME.  You have to give it time to reap the benefits.  So spend the little bit of effort required now and get that money working for you.  Your future self will thank you, I promise!

P.S. I made a dynamic excel template where you can play around with the amount invested and the rate of return to prove to yourself how big of a deal this really is.

Check out the Time Value of Money Calculator

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