Investopedia/James Chen: What Is the Time Value of Money (TVM)?

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Time Value of Money (TVM)
Reviewed by James Chen
Updated Apr 14, 2019
What Is the Time Value of Money (TVM)?

The time value of money (TVM) is the concept that money available at the present time is worth more than the identical sum in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received. TVM is also sometimes referred to as present discounted value.
Understanding The Time Value Of Money
Understanding Time Value of Money (TVM)

The time value of money draws from the idea that rational investors prefer to receive money today rather than the same amount of money in the future because of money's potential to grow in value over a given period of time. For example, money deposited into a savings account earns a certain interest rate and is therefore said to be compounding in value.

Further illustrating the rational investor's preference, assume you have the option to choose between receiving $10,000 now versus $10,000 in two years. It's reasonable to assume most people would choose the first option. Despite the equal value at time of disbursement, receiving the $10,000 today has more value and utility to the beneficiary than receiving it in the future due to the opportunity costs associated with the wait. Such opportunity costs could include the potential gain on interest were that money received today and held in a savings account for two years.
Basic TVM Formula

Depending on the exact situation in question, the TVM formula may change slightly. For example, in the case of annuity or perpetuity payments, the generalized formula has additional or less factors. But in general, the most fundamental TVM formula takes into account the following variables:

    FV = Future value of money
    PV = Present value of money
    i = interest rate
    n = number of compounding periods per year
    t = number of years

Based on these variables, the formula for TVM is:

FV = PV x [ 1 + (i / n) ] (n x t)
TVM Example

Assume a sum of $10,000 is invested for one year at 10% interest. The future value of that money is:

FV = $10,000 x (1 + (10% / 1) ^ (1 x 1) = $11,000

The formula can also be rearranged to find the value of the future sum in present day dollars. For example, the value of $5,000 one year from today, compounded at 7% interest, is:

PV = $5,000 / (1 + (7% / 1) ^ (1 x 1) = $4,673
Effect of Compounding Periods on Future Value

The number of compounding periods can have a drastic effect on the TVM calculations. Taking the $10,000 example above, if the number of compounding periods is increased to quarterly, monthly or daily, the ending future value calculations are:

    Quarterly Compounding: FV = $10,000 x (1 + (10% / 4) ^ (4 x 1) = $11,038
    Monthly Compounding: FV = $10,000 x (1 + (10% / 12) ^ (12 x 1) = $11,047
    Daily Compounding: FV = $10,000 x (1 + (10% / 365) ^ (365 x 1) = $11,052

This shows TVM depends not only on interest rate and time horizon, but also on how many times the compounding calculations are computed each year.
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Related Terms
Continuous Compounding
Continuous compounding is the process of calculating interest and reinvesting it into an account's balance over a theoretically infinite number of periods.
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Compounding
Compounding is the process in which an asset's earnings, from either capital gains or interest, are reinvested to generate additional earnings over time.
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Cumulative Interest
Cumulative interest is the sum of all interest payments made on a loan over a certain time period.
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Future Value (FV)
Future value (FV) is the value of a current asset at a date to come based on an assumed rate of growth over time.
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Breakup Value
The breakup value is the sum-of-parts value of a publicly traded company.
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How to Calculate Present Value, and Why Investors Need to Know It
Present value is the concept that states an amount of money today is worth more than that same amount in the future. In other words, money received in the future is not worth as much as an equal amount received today.
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