Section 4 – Time Value of money

Table of Contents

Role of money in our life

We, as a human, need money to survive at every step of life in this materialistic world. Even our basic needs like food, clothing and shelter can be fulfilled with the help of money. After the barter trade age, all products and services are measured in terms of money (Currency).

In our professional & personal space also, majority of relationships is based on the wealth status of an individual. Hence, it can be said that money is not only the currency notes and coins but it includes everything that comes to us with its help.

Purchasing power of money and inflation

Purchasing power: Purchasing power refers to the value of Rupees (currency) expressed in terms of the number of goods or services that can be bought by one unit of currency. We often hear from our grandparents that things were very cheap in their time. They say that earlier, they used to buy vegetables for the whole family for just Rs twenty only. Today the same vegetable is not available even for 200 rupees. It is because rising prices reduce the purchasing power of currency over time.

Inflation: Inflation refers to the rate at which the value of a currency falls down and therefore the general level of prices for goods and services gets higher.

Inflation is measured as the annual rate of increase in the average level of prices. The rise in price puts extra pressure on your savings and investments. It reduces the purchasing power of your saved money. As a result, after a few years, the amount you have saved will fetch you a lesser number of goods.

Time value of money

Worth of Rs 1000 you receive today may not be the same after 5 years. The potential earning capacity of money, rate of inflation and purchasing power of money are the factors that create a difference in worth of money with the time. For example, Cost of engineering education will not be same after 5 years. Always remember that inflation erodes the value of money.

While planning financial provisions for future goals, always consider the present value and expected future value and make provisions according to future value.

An example of time value of money:

     
GoalsPresent cost of goalsMoney required after how many yearsAssumed Inflation rateFunds required in future
Education600000104%888147
Marriage1500000184%3038725
House7500000124%12007742

Financial goals and how right investments can help us to achieve it

As detailed in above given table, there may be difference in present cost and future cost of a financial goal.

After calculating the tentative future cost of a financial goal, we need to make a sound investment planning to achieve the goal in due course of time.

Let us have an example to illustrate the concept of right investment –

Suppose a person wants to create fund for higher education of his child. He can select one- time lump sum investment or periodical monthly investment or year wise investment.

Present age of his child8 years
Higher education of the child will start at the age of On attainment of 18 year
Time duration for investment is 10 years
Present cost of the higher education is Rs 15,00,000
Rate of inflation is 0.04
Inflation adjusted cost of the higher education after 10 years will beRs 22,20,366
Expected returns on investment is 0.12
One Time investment required Rs.7,14,899
Annual Investments required Rs.1,26,526
Monthly investments required Rs.9,652

If a person investing with a sound investment planning for higher education of his child, he can easily achieve the goal with an option to invest lump sum or periodically. It is important to select a suitable investment avenue to get the desired returns on your investment.

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