Time Value of Money and Inflation Risk: $100 Today is Worth More Than $100 Tomorrow

3 years ago

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Time Value of Money and Inflation Risk

 $100 Today is Worth More Than $100 Tomorrow

“Time value of money” is a term that simply states one dollar received today is worth more than one dollar received in the future. You may think “Isn’t it a dollar just a dollar?” Well yes, a dollar is in fact just a dollar, but the financial term “time value of money” (also referred to as TVM) reminds us of one basic, but fundamental fact: that dollar is earning interest all the time.

The longer a dollar is invested and earning interest, the more interest and money it accumulates. Below is a simple example of what could happen by investing just $100.

  • Put $100 at the beginning of the year in a savings account that earns 1% interest per year, at the end of the year you will have $101 just by letting it sit there.
  • The following year, your account may earn 1% on the amount it has at the beginning of the year ($101) and therefore, could finish the year with a total of $101 plus $1.01 (1% of $101) equaling $102.01.
  • By letting your $100 just sit in the bank for two years, you could make $2.01. Even though the reward might be small, it is true that $100 today could be worth more than $100 tomorrow.

Now, what happens when instead of going to the bank, and depositing your $1 or your $100, you go home and stick it in your sock drawer or under the mattress? You are then exposed to what is called “inflation risk.” Inflation is simply defined as a general increase in prices. It is the risk of money not being able to buy as many goods or services because of a rise in prices.

  • You put a $1 bill in your wallet when the price of your favorite power bar is 90 cents.
  • You may be unaware of current economic conditions, but say the ingredients in that power bar become more expensive for the company that produces it due to inflation.
  • Two months later, you go to the store to buy the same bar that was 90 cents before, now it’s $1.10 and you can’t afford it.

Remember, risk is not a certainty, but it is definitely something to be aware of

-Santiago Munoz

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The views and opinions expressed are those of the authors do not necessarily reflect the official policy or position of Cabana or its affiliates. Any content provided by our bloggers or authors are of their opinion, and are not intended to malign any religion, ethnic group, club, organization, company, individual or anyone or anything.

Information presented is believed to be current. It should not be viewed as personalized investment advice. All expressions of opinion reflect the judgment of the authors on the date of publication and may change in response to market conditions. You should consult with a financial advisor before implementing any strategies discussed. Content should not be viewed as an offer to buy or sell any of the securities mentioned or as legal or tax advice. You should always consult an attorney or tax professional regarding your specific legal or tax situation.

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