Why investors need to understand the time value of money

Have you ever thought about which is more valuable, the 1000 dollars you receive now or the 1000 dollars you receive next year? On the surface, the numbers are the same, but in reality, the former is worth much more. This is the core of the time value of money concept (концепция временной стоимости денег) — receiving funds now is always preferable to receiving the same amount in the future.

Why money now is more valuable than money in the future

In simple terms, this is a question of opportunity cost. When you choose to delay receiving funds, you are actually losing all the possibilities of using that money during that time. You could have deposited the money in a high-interest account, made investments, or used it for other purposes, but you missed out on all of them.

For example: A friend borrows $1000 from you, saying he can only pay it back next year. If he gives you the money now, you can invest it in a product with a 2% annual return. But if you wait for 12 months, not only do you lose the potential $20 earnings during that year, but you also have to consider the erosion caused by inflation—meaning the purchasing power of $1000 a year later will be weaker.

Two Key Calculation Methods: Future Value and Present Value

Understanding the time value of money requires mastering two opposing concepts.

Future Value (FV) Answers the question: How much will the money I invest today be worth next year? Assuming you invest $1000 at an annual interest rate of 2%:

FV = $1000 × 1.02 = $1020

If the period is two years:

FV = $1000 × 1.02² = $1040.40

The general formula is: FV = I × (1 + r)^n

Where I is the initial capital, r is the interest rate, and n is the number of time periods.

Present Value (PV) is calculated in reverse: How much is a certain amount of money worth today? A friend says he will pay you $1030 instead of $1000 in a year. Is this transaction worth it? Take out the calculator:

PV = $1030 ÷ 1.02 = $1009.80

The results indicate that my friend's plan is indeed more favorable—its present value is $9.80 more than simply taking $1000 today.

Calculation formula: PV = FV / (1 + r)^n

The compound interest effect can turn small money into big money

In the calculations above, we used compound interest—that is, interest on interest. It may not seem special, but it creates a snowball effect of growth in long-term investments.

What if the compounding frequency changes? The annual interest rate is still 2%, but if compounding is done quarterly (4 times a year) instead of annually:

FV = $1000 × (1 + 0.02/4)^(1×4) = $1020.15

At first glance, an additional 15 cents may seem insignificant, but when applied to larger amounts and over longer time spans, this difference can turn into real wealth growth.

How Inflation Erodes Your Money

Here is an awkward reality: if the interest rate is 2% but inflation is 3%, your actual purchasing power is actually decreasing. The concept of time value of money becomes more complex.

Inflation is difficult to predict and hard to combat. Different countries have different methods for calculating inflation indices, resulting in varying figures. Investors typically adjust their decisions using real interest rates (nominal interest rates minus inflation rates), but this is often based on historical data and forecasts, which come with significant uncertainty.

Time Value Decisions in Cryptocurrency Investment

In the field of digital assets, the concept of time value of money has become particularly relevant.

Take Staking as an example. You need to choose one of two options: keep 1 Ethereum (ETH) now, or lock it for 6 months for staking to earn a 2% return. Considering the various staking options with different yields, using time value calculation methods can help you find the optimal choice.

Bitcoin (BTC) investment is the same. BTC is viewed as an anti-inflation asset, but its supply gradually increases until it reaches its cap—this means it has inflationary attributes from a circulation perspective. Is it better to buy BTC for $50 now or wait until next month when you get paid to use $50 to buy it? According to the principle of time value of money, buying now is more cost-effective. However, in reality, the price of BTC is highly volatile, which breaks the simple mathematical logic.

Final Thoughts

Although we have concretized the concept of time value of money using formulas, you may have understood this principle intuitively long ago. Interest rates, yields, inflation - these are all deeply embedded in our economic lives.

For large companies and investment institutions, these calculations are crucial. Even a one percent difference in interest rates can have a huge impact on large transactions. For you who are investing in cryptocurrencies, understanding this principle can help make more rational decisions—whether to act immediately or wait for opportunities should be based on the actual calculation of time value, rather than purely emotional judgments.