Time Value of Money — The Dollar Dictionary

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Finance

Time Value of Money

The principle that a sum of money is worth more today than the same sum in the future, because money today can be invested and grow.

The time value of money is expressed in two directions. Future Value: if I invest £1,000 today at 6% annually, what will it be worth in 10 years? (Answer: £1,791.) Present Value: if I'll receive £1,000 in 10 years and my required return is 6%, what is that worth to me today? (Answer: £558.) These calculations are the engine behind almost every valuation model in finance.

The discount rate is the key variable. Use a higher discount rate and future money is worth less today. Use a lower rate, and future cash flows look more valuable. This is why rising interest rates crushed the valuations of high-growth tech companies (whose profits are far in the future) in 2022 — higher rates make distant future cash worth far less in present value terms.

Would you rather have £100 today or £100 in five years? Today, obviously. That instinct is the time value of money. The £100 today can be invested, earn returns, and become significantly more than £100 by the time five years pass. Every finance calculation — from mortgage rates to corporate valuations to pension planning — rests on this single foundational idea.

Real world: Lottery winners often face a choice: take $10 million now (lump sum) or $600,000 per year for 25 years ($15 million total). Financial advisors almost always recommend the lump sum, because £10 million invested today at 7% annually grows to over $54 million over 25 years — far more than the $15 million payment plan. The time value of money makes early money dramatically more valuable than future money.

💡 The time value of money is why starting to invest at 18 beats starting at 28 — time isn't just money, it's a multiplier.

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