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Episode 124: The Time Value of Money: Why Your Money is Worth Less and Less

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Go Premium for only $9.99 a year and access exclusive ad-free videos from Alanis Business Academy. Click here for a 14 day free trial: http://bit.ly/1Iervwb View additional videos from Alanis Business Academy and interact with us on our social media pages: YouTube Channel: http://bit.ly/1kkvZoO Website: http://bit.ly/1ccT2QA Facebook: http://on.fb.me/1cpuBhW Twitter: http://bit.ly/1bY2WFA Google+: http://bit.ly/1kX7s6P Listen to Alanis Business Academy on the go by downloading our new podcast: iTunes: http://bit.ly/1dwKyWi Stitcher: http://bit.ly/PvPjoa Tunein: http://bit.ly/1gLsDH4 The time value of money, commonly abbreviated as simply TVM, is the idea that money loses value over time. You may have heard the saying one dollar received today is worth more than one dollar received tomorrow. What this attempts to explain is the fact that the value of your hard earned money decreases each and every day. As an example, lets say that that your friend asked you for $500 with the promise to repay you that same amount in twelve months. Although you may be inclined to help your friend out this wouldn't be a great financial decision. But why? You're still receiving that same $500 you loaned him or her twelve months ago. The truth is, that although the numerical value of your $500 remains unchanged, you incur several costs by not having it in your possession. The first and probably the most obvious cost that you incur is inflation. Inflation is the increase in the price of goods and services over a period of time. Inflation generally runs at about two percent annually, although it has been quite less as of late. So if you hold your money for that period of time, what you can do with that money actually decreases. The financial equation to determine a present value is as follows: PV equals FV divided by one plus i to the nth power. In this equation, PV is the present value of our money and what we are trying to determine. FV represents that future value of our money, which is $500 . i represents the interest rate that we intend to discount or reduce our $500 by. Generally for discounting purposes the interest rate represents what we could've received if you had the money in our possession and put it to good use. In this case, we are going to discount our money by an inflation rate of two percent to reflect its diminished value. The last bit of data we need is the number of periods or n, which will be one to reflect the number of years we are going to discount our $500 by. The second reason that money decreases in value over time is due to opportunity costs. An opportunity cost represents what you give up by loaning the $500 to your friend. More specifically, the opportunity cost represents the next best alternative. What that is depends upon your unique situation. It could be investing in the stock market, placing the money in a savings account, or even spending it on new clothes. Unfortunately you incur an opportunity cost by giving up possession of your money. Now as a result of both inflationary pressures and opportunity costs your $500 will be worth less in twelve months. This is why banks charge interest on loans and why consumers expect to earn some type of interest when they place their money in a bank. It's simply being compensated for the costs that they incur by not having the money in their possession at this moment in time.
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Text Comments (13)
w x (1 year ago)
Amazing explanation!!
Mohab Omar (1 year ago)
Thank you so much for this detailed and simplified way of explaining, i just wonders if this inflation rate is constant, and does it changes from country to other
andre (3 years ago)
Very good explanation... easy to understand..Thank-you
+andre Thank you Andre! I'm glad that you enjoyed it. 
rajat79foryou (3 years ago)
Sir, While calculating FV for given variables like interest rate, period and Present Value  can inflation rate may be subtracted from the rate of interest to arrive at the FV taking inflation into account.For e.g. r=7%, Inflation=0.8% .Can we substitute 6.2% as the effective interest rate to arrive at the FV. Thanks for your informative lesson.
+rajat79foryou Absolutely! That would be what's called a "real interest rate", which reduces the nominal interest rate by the inflation rate. 
Why does money lose value over time? Find out in: The Time Value of Money. 
Thanks! Of course. I use Sketchbook Express, which allows me to re-create kind of a digital blackboard, in conjunction with a Wacom Bamboo tablet for writing. Then I use a screen-capture software called Screenflow, which is for Mac to actually capture the writing and do some basic editing. Hope this helps!
Glad to hear that! Thanks for watching.
tessy (4 years ago)
Interesting,i enjoyed it
Glad you enjoyed it! Thanks for watching.
Glad it was of help to you Sydnee. Thanks for taking the time to provide feedback as well.
Sydnee (4 years ago)
This video really helped me understand the concept. I've watched quite a few but always end up confused. My only criticism is the narrator speaks too quickly and rushes through the calculation. Overall best video on this topic.

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