The Time Value of Money is an important factor when looking at any type of investment analysis. The basic calculations refer to the question of how much an investment made today will produce in the future. A sales mentor of mine once said, “I would rather make a quick nickel than a slow dime.” Although his reasons for saying it differed slightly, the economic principle he espoused holds true in that a dollar received today is worth more than a dollar received at some point in the future for a few reasons:
Risk. Simply put, the quicker you get your money back, the less risk exposure you have. Holding money in an investment for long periods of time invites risk such as default, loss of reinvestment funds, and degradation of the investment.
Inflation. Except in extraordinary times of deflation, the US Dollar’s purchasing power declines over time. A dollar today can buy more goods (investments) and services than at a period of time 10-20 years down the road.
Opportunity Cost. The idea here is that funds received today can be re-invested in another opportunity, thereby compounding the interest received. Once again, due to inflationary forces, the money reinvested today has greater purchasing power than an opportunity cost in the future.