Time Value of Money & FUTURE ...!!!

De-jargoned: Time value of money
The real value of money essentially has to consider the impact of inflation on the purchasing power
Lisa Pallavi Barbora

If somebody gave you a choice to receive Rs.50,000 now or after three years, what would you choose? This one is simple, you will choose to receive the money now. Intuitively, you know you can do a lot more with the money today and you can even invest it so that three years later, it is worth more. Now if somebody gives you a choice, would you prefer Rs.50,000 today orRs.60,000 after three years? This is a harder choice to make and you need to calculate the time value of money to decide. There are two important thing you need to consider for that—the interest you can earn on your money and the rate of inflation or the change in purchasing power of your money.
Future Value of moneyThe future value of money can be calculated to tell you how much your money will be worth after a defined period of time. Let’s say you leave the Rs.50,000 you have received today in your savings bank account. Then after three years, it will be worth Rs.56,341 assuming that the interest offered on the savings account is 4% and the interest due is compounded quarterly.

The formula for calculation is: amount*(1+(interest rate))^number of periods. So, in this case it can be calculated as 50,000*(1+(.04/4))^12.

Alternatively, if you had instead invested in a three-year fixed deposit, with annual compounding your return would amount to Rs.64,751 assuming a 9% per annum rate.
Now that you know the future value of your money, you can say with confidence that you would prefer to have Rs.50,000 today. But remember that this is the nominal value of money.
Nominal vs real value of moneyThe real value of money essentially has to consider the impact of inflation on the purchasing power. Inflation measures the rise in cost of goods and services. In other words, every year things you buy become more expensive by a certain margin and this margin is measured by inflation. At present the Consumer Price Index (CPI), or what’s referred to as the retail inflation, is around 11%. This means the total value of your basket of goods has increased 11% in the last year and your money is worth that much less. If you consider that in the last year or so the CPI has been around 9-10% and extrapolate 9% (per annum) as the average for the next three years, the value of your nominal Rs.64,751 sum is still only Rs.50,000. This happens because at an average inflation rate of 9%, each year your money is worth that much less. You have to discount the value of your money by the inflation figure to ascertain the real value.

The calculation is simple: amount/(1+discount rate)^number of periods. In this case the discount rate is the inflation.

Understanding the difference between real and nominal value will help you make a better choice for investing money today and enhancing the effectiveness of the future value of your money. Lastly, you have to consider things such as taxation on earnings to know the final money in hand.
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