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Start hereLevel 1BasicsUpdated The time value of money
A thousand euros today and a thousand euros ten years from now are not the same thing, even though the amount is the same. This is the most fundamental idea in investing, and it explains why it's worth investing at all rather than just keeping your money.
Why a euro today is worth more
Money has a time value for three reasons, and they all point in the same direction. First, a euro received today can be put to work right away. A year from now it's no longer a euro but a euro plus the return. Second, inflation eats into purchasing power: the same hundred euros buys less next year than this year. Third, future money always involves uncertainty. A promise of payment isn't as certain as money in your hand.
This leads to a rule that applies to all investing: the value of money depends on when it's available. When you compare two options in which money moves at different times, you can't just compare the amounts. You have to move them to the same point in time before the comparison is fair.
Present value and future value
Moving money in time works in two directions. Future value answers the question "how much will this amount grow to?": a thousand euros at a seven percent annual return becomes about €1,970 in ten years. Present value answers the reverse question "how much is that future amount worth now?": a thousand euros received ten years from now is worth about €508 today with the same expected return.
Calculating present value is called discounting, and the percentage used is called the discount rate. It isn't a mysterious number but simply the return you could get elsewhere with the same risk. The higher the alternative return, or the further in the future the money is, the less it is worth today.
Opportunity cost
The other side of time value is opportunity cost: every euro has a price, which is the return it would have earned elsewhere. Ten thousand euros sitting in a current account doesn't seem to cost anything. The account charges nothing and the balance doesn't go down. Yet it does cost something, because the same money could have been earning a return.
This is why "I'm not doing anything" is also a decision. Waiting for a better moment, keeping cash on the sidelines or paying off a loan early are all choices with an opportunity cost. That doesn't mean they're wrong (an emergency fund belongs in cash, and expensive debt is worth paying off), but that it's worth knowing the price.
Nominal and real
There are two ways to talk about return. Nominal return is the number you see in your account. Real return is the nominal return minus inflation, in other words how much your purchasing power actually grew. If your portfolio returned five percent and inflation was two, the real return was about three percent.
The difference is decisive over long periods. Two percent inflation halves the purchasing power of money in about 35 years, even though the amount in the account doesn't change at all. This is the quiet reason why saving alone isn't enough for long-term goals: an account with zero return isn't risk-free. It carries a certain small loss.
Where you need this
Time value doesn't stay theoretical. It's behind every investment decision. The value of a share is the present value of its future cash flows. The price of a bond is the present value of its future coupons and principal, and that's exactly why a bond's price falls when interest rates rise: the same future money is discounted at a higher rate. Paying down a mortgage, saving for retirement and a child's portfolio are all questions of when the money will be available.
The next chapter shows the same phenomenon from the other side: when money is left to earn a return for long enough, growth accelerates on its own. Compounding →
This content is for information purposes only and should not be construed as investment advice or a recommendation. Investing always involves the risk of losing capital. The value of financial instruments and investments can go up or down, and past performance is no guarantee of future returns.
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