Time and Your Money

I do not quite know the origin and meaning of the saying "time is money." The sense in which it is used by most people is that if you do not use your time productively then you will loose. In other words when you employ your time in one way you could incur costs in terms of lost opportunities in other ways.

While the opportunity cost aspect may be true, the relationship between time and money in the context of savings and investments very extra ordinary and that is what I want to explore in this article.

A smart observer of the laws of physics as well as economics once said that the two most powerful forces in the world are gravity and the time value of money. It would be hard to argue that point. The time value of money is the foundation of all financial planning, and a thorough understanding of this powerful concept is vital if we are to achieve financial security throughout life.

Time and Compound Interest
The concept of compounding has to do with interest on interest. For instance if I have a principal of $ 100,000 at a monthly interest rate of 2%, after one month the interest will not only be calculated on principal i.e. $ 100,000 but on the principal plus interest due i.e. $ 102,000.

If you saved money over a period of time such that the interest kept compounding, the money will grow at a much faster rate than if it was earning simple interest. The miracle of compounding as it is called by financial experts is the most simple yet least used concept by most people.

The downside is when you borrow money at a compound interest, which is very common with loans provided by informal money lenders. You will soon find that you can keep in step with the interest repayment and after a little while. I have calculated and found out that if you borrowed money at 1% monthly compounding interest and did not make any payments for 12 months, the outstanding balance would double!

It is not surprising that we keep reading in the news about borrowers being taken to court and the interest outstanding is far more than the principal amount they borrowed. It is because they did not properly understand the effect of time and compounding interest.

Time and Inflation
The relation between and effect of time and inflation is another important concept when dealing with money. Inflation has to do with the fact the prices of most things rise over time. The rate of inflation is the measure of the average price change over the specified period.

Simply put if the rate of return on your savings or investment is lower than the rate of inflation then you are actually loosing money. This is because if your return does not match or surpass inflation then the amount saved or invested would not purchase the same amount of consumption say a year later as it is doing the day you saved.

Inflation can be a powerful destroyer of wealth over time. Even in economies with low inflation you need to ensure that the return you are getting whether on savings or investments is higher than the rate of inflation. People who hold bank savings accounts in particular need to always check if the bank manager is making you to gain or loose money by comparing the interest rate and prevailing inflation rate.

Time and Discounting
Discounting is nothing more than the opposite side of compounding! The time value of money is a two-way street. You start with the premise that a shilling you get today is worth more than a shilling you'll get at some point down the road, because you can invest today's shilling and earn interest on it starting today. (And add to that the thought that inflation hasn't had a chance to erode today's shilling yet.)

Conversely, a future shilling is worth less in today's terms, so you "discount" it to get its present value. "Discounting" is a way of expressing the loss of interest income and/or erosion by inflation that you suffer by not getting that shilling until some point in the future. You can determine the discount rate by using a financial calculator or by using good old-fashioned standard tables.

Business people are suffering the effect of discounting often but without realising or understanding it. If a client asks to delay payment for items sold at today's price, discounting tells us that what you receive will worth far less. Take the case of a person who can invest at interest rate of 9% per annum (possible with treasury bills) and is owed $ 100,000. If payment is delayed for 1 year the money will be worth only $ 91,743 but if payment is delayed for 2 years the value falls to $ 84,618.

Well, I hope the time you spent reading this article has been spent in a worthwhile manner.