Time Value of Money

9 min read

Time Value of Money

A franc today is worth more than a franc tomorrow --- not because of inflation, but because today’s franc can be used, invested, or deployed. Time itself has a price.

What is it?

The time value of money (TVM) is the principle that a unit of currency available now is worth more than the same unit available in the future. This is the single most important concept in financial valuation. Every investment decision, every loan, every pension calculation, and every business valuation rests on it.1

The intuition is straightforward. If someone offers you CHF 1,000 today or CHF 1,000 in one year, you should take it today. Why? Because today’s CHF 1,000 can be deposited, invested, or used productively. In a year, it could be CHF 1,050 or CHF 1,070 depending on what you do with it. The future CHF 1,000 cannot do anything until it arrives.

But the deeper insight goes beyond opportunity. Money available now gives you optionality --- the ability to respond to situations that have not yet arisen. A franc in your pocket today can be deployed when an opportunity appears, used to solve an emergency, or simply held as flexibility. A franc arriving in twelve months cannot do any of these things until it materialises.

This is why lenders charge interest. When you borrow CHF 10,000, the lender is giving up the use of that money for the duration of the loan. The interest rate is the price of time --- compensation for surrendering optionality. From the credit-and-trust perspective, it is also the price of trust: the lender trusts that you will return the money, and the interest rate adjusts for the risk that you will not.2

In plain terms

Money has a time dimension. CHF 1,000 today and CHF 1,000 next year are not the same thing, even though they look identical. The difference is what you can do with the money in the intervening time.

At a glance

How does it work?

1. Future value: what today’s money becomes

If you invest CHF 1,000 today at 5% annual return, after one year you have:

FV = PV × (1 + r) = 1,000 × 1.05 = CHF 1,050

After two years: CHF 1,000 × 1.05 × 1.05 = CHF 1,102.50. After ten years: CHF 1,000 × (1.05)^10 = CHF 1,628.89. The formula is simple but the effect is not linear --- it accelerates. This is the foundation of compound-interest.

The key variables are:

  • PV (present value): what you start with
  • r (rate): the return per period
  • n (periods): how long the money works

Small changes in rate or time produce large changes in outcome. CHF 1,000 at 5% for 30 years becomes CHF 4,322. At 7% for 30 years: CHF 7,612. The 2% difference in rate nearly doubles the outcome over three decades.

Think of it like...

A snowball rolling downhill. The snow on the ground is the interest rate. The slope length is time. A slightly snowier hill (higher rate) or a longer slope (more time) produces a dramatically bigger snowball at the bottom. The snowball does not grow linearly --- it grows by accumulating mass that itself accumulates more mass.

2. Present value: what future money is worth today

Discounting is the reverse operation. If someone promises you CHF 1,050 in one year, what is that promise worth today? If your alternative is a 5% investment:

PV = FV / (1 + r) = 1,050 / 1.05 = CHF 1,000

The promise of CHF 1,050 next year is equivalent to CHF 1,000 today. They have the same present value at a 5% discount rate.

This is how all financial assets are valued. A bond paying CHF 50 per year for ten years and returning CHF 1,000 at maturity is worth the sum of each payment discounted back to today. A business expected to generate CHF 100,000 per year for twenty years is worth the sum of those future cash flows, each discounted. The concept is called discounted cash flow (DCF) and it is the backbone of corporate valuation.3

The discount rate reflects the minimum return you require to justify locking up your money. It incorporates your opportunity-cost (what else could you do with the money?), the risk of the investment (will the future cash actually arrive?), and the time horizon (how long is your money committed?).

3. The time-risk connection

Time and risk are intertwined. The further into the future a payment lies, the more uncertain it is. A company promising you CHF 1,000 next month is almost certainly good for it. The same company promising CHF 1,000 in twenty years? The company may not exist. This is why longer time horizons require higher discount rates --- the uncertainty compounds alongside the money.1

graph TD
    subgraph "Same CHF 1,000 promised"
        Y1["In 1 year<br/>PV ≈ CHF 952<br/>low uncertainty"]
        Y5["In 5 years<br/>PV ≈ CHF 784<br/>moderate uncertainty"]
        Y20["In 20 years<br/>PV ≈ CHF 377<br/>high uncertainty"]
    end
    style Y1 fill:#27ae60,color:#fff
    style Y5 fill:#f39c12,color:#fff
    style Y20 fill:#e74c3c,color:#fff

At a 5% discount rate, CHF 1,000 promised further in the future is worth progressively less today.

4. Why this matters for your decisions

Every financial decision you make involves a trade-off across time. Spending CHF 100 today means not investing that CHF 100 for the future. Investing CHF 100 today means not spending it now. The time value of money makes these trade-offs explicit.

The concept also explains why your brain struggles with financial planning. present-bias is the psychological tendency to overvalue the present relative to the future --- essentially, your brain applies too steep a discount rate. A rational discount rate might be 5%. Your brain’s emotional discount rate can be 50% or higher, which is why CHF 100 in your hand feels worth far more than CHF 150 arriving in two years, even though the math says the opposite.

Understanding TVM does not eliminate present bias. But it gives you the framework to recognise when your intuition is mispricing the future.

Why do we use it?

Key reasons

1. Valuation. Every financial asset --- a stock, a bond, a business, a real estate property --- is ultimately valued by discounting its expected future cash flows to the present. TVM is the engine. 2. Decision comparison. TVM lets you compare options that occur at different times. “Should I take CHF 90,000 now or CHF 100,000 in two years?” is unanswerable without a discount rate. 3. Cost of delay. TVM quantifies what procrastination costs. Every month you do not invest is a month of compounding you forfeit --- and compounding is back-loaded, so early months matter disproportionately.

When do we use it?

  • Investing: calculating whether an asset is priced above or below the present value of its expected returns
  • Borrowing: understanding the true cost of a loan (interest is the price of TVM)
  • Retirement planning: determining how much to save now to reach a target future amount
  • Business valuation: discounting projected cash flows to determine what a company is worth today
  • Personal decisions: comparing financial options that unfold over different time horizons

Rule of thumb

The Rule of 72 gives a quick mental estimate: divide 72 by the annual return rate to get the approximate number of years for your money to double. At 6%: ~12 years. At 8%: ~9 years. At 12%: ~6 years. Fast and surprisingly accurate.

How can I think about it?

Analogy: a seed vs a loaf of bread

Money today is a seed. Money in the future is a loaf of bread. If someone offers you a seed now or a loaf in a year, which is better? It depends on the soil. If the seed can grow into a wheat field that produces many loaves, the seed is worth more. If the soil is barren, take the bread. The “soil” is your available return rate --- the opportunity you have to make the seed grow.

Analogy: a plane ticket

A plane ticket for tomorrow costs more than the same ticket booked six months ago. Why? Flexibility has a price. Money today is like a last-minute ticket --- you can go anywhere. Money locked for five years is a pre-booked ticket --- the destination is fixed, the flexibility is gone. The interest rate compensates for surrendered flexibility.

Concepts to explore next

ConceptStatusWhat it adds
compound-intereststubThe exponential growth that TVM enables over long horizons
opportunity-costcompleteWhat you give up by choosing one use of money over another
depreciationcompleteThe mirror image --- how asset values decline over time
present-biasstubWhy your brain systematically misprices future money

Check your understanding

Where this concept fits

Where this concept fits 

graph TD
    MST[Money as Social Technology] --> TVM[Time Value of Money]
    CT[Credit and Trust] --> TVM
    TVM --> CI[Compound Interest]
    TVM --> DEP[Depreciation]
    TVM --> PB[Present Bias]
    TVM --> SR[Savings Rate]
    TVM --> ROI[Return on Investment]
    TVM --> VA[Valuation]
    TVM --> IR[Interest Rate]
    style TVM fill:#4a9ede,color:#fff

Sources

Footnotes

  1. Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of Corporate Finance (13th edition). New York: McGraw-Hill. Chapters 2—3 on present value and the time value of money. ↩ ↩2

  2. Fisher, I. (1930). The Theory of Interest. New York: Macmillan. The foundational work on the economic meaning of interest rates as the price of time preference. ↩

  3. Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset (3rd edition). New York: Wiley. Chapter 2 on discounted cash flow as the universal valuation framework. ↩

Graph View

Backlinks