When investing your money, there are a lot of different variables to take into consideration. One of them is the principle of the time value of money. 

It’s a common term in the financial sector but can be unknown territory for new investors, especially in crypto. The time value of money looks at how money appreciates in value just by existing, giving a tool for investors to create a long-term investment strategy. 

The time value of money can be a bit complex to understand, but when you do, it will be an important tool in your investment journey. It’s possible to calculate through a formula, which we will walk through in this article. We will also look at how it can be useful in a crypto investment setting.

What is the Time Value of Money?

The time value of money refers to the principle that money available today is worth more than the same amount of money available in the future. The main reasoning behind this theory and principle is that money can earn interest with time or be invested in various ways to generate long-term returns.

Source: Tally Solutions

In other words, the time value of money acknowledges that money has a “time cost” associated with it, meaning that the value of money changes over time due to factors such as inflation, interest rates, opportunity cost, and other potential factors that are harder to predict.

The concept of the time value of money is important in financial decision-making. It helps individual investors and businesses determine the present value of future cash flows. It allows them to calculate future investment projects to make the best possible choices for either borrowing or lending out money. 

How do you calculate the Time Value of Money?

To calculate the time value of money, you will need to look at three different variables. The present value of the money (PV), the interest rate, and the time period of the investment. 

The formula for calculating the future value (FV) of a present value (PV) amount over a period of time (t) at a given interest rate (r) is:

FV = PV x (1 + r)^t

Conversely, the formula for calculating the present value (PV) of a future value (FV) amount over a period of time (t) at a given interest rate (r) is:

PV = FV / (1 + r)^t

In both cases, the interest rate must be expressed as a decimal, not a percentage. Additionally, the time period must be in the same units as the interest rate (for example, years for an annual interest rate).

For example, let’s say you want to calculate the future value of $10,000 invested for five years at an annual interest rate of 5%. Using the formula, the calculation would be:

FV = $10,000 x (1 + 0.05)^5 = $12,762.82

This means that in five years, your investment would be worth $12,762.82 if it earned an annual interest rate of 5%.

Similarly, if you wanted to calculate the present value of $12,762.82 that you expect to receive in five years at an annual interest rate of 5%, the calculation would be:

PV = $12,762.82 / (1 + 0.05)^5 = $10,000

This means that you would need to invest $10,000 today at a 5% interest rate to have $12,762.82 in five years.

Why should we care about it in crypto?

So why should you care about the time value of money as a crypto investor? Well, generally, it’s important to be aware of to calculate the expected return on future trades. Crypto traders need to consider not only the price of the asset they are trading but also the interest rates, inflation, and other factors that affect the value of money over time. By factoring in the time value of money, traders can determine the expected return on their trades and make informed decisions about buying or selling assets. This goes for crypto investments as much as it does for regular investments. 

Source: Magnimetrics

Another aspect where the time value of money is important is when considering the opportunity cost of holding a particular crypto asset. If an investor holds a cryptocurrency for an extended period of time, they are giving up the opportunity to invest that money elsewhere and earn a return there. Therefore, they need to consider the time value of money when deciding whether to hold or sell the asset.

Before sending you off with a new investment term in hand, here are a few tips to keep in mind when investing with the time value of money. 

Tip 1: 

Understand the concept and formula before you start actively using it. Without the correct understanding, you might not make the best investment decisions. 

Tip 2: 

Consider the interest rate before making a decision. The interest rate is a key factor in determining the time value of money. When evaluating an opportunity, consider the interest rate and how it will impact the value of your investment over time.

Tip 3:

Choose long-term investments as your key focus. Since the time value of money favors investments that generate returns over a long period of time, it’s generally a good idea to choose long-term investments.

Tip 4: 

Always be aware of the risk compared to the return on your investment. All investments have some level of risk, and the potential return on investment should be balanced against the level of risk involved. When evaluating investment opportunities, choose investments that align with your risk tolerance.

Tip 5: 

Use a specified calculator to get your numbers straight. Since the time value of money is calculated through a specific formula, make sure to use a specified calculator online to get the right results. You wouldn’t want to make a human error in your calculations and have it impact your investment.

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