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The Time Value of Money

Hemant Kumar Agarwal | November 19, 2021

The money in our possession today gradually loses its value with time; we must find ways to circumvent it. 

The Time Value of Money

Financial freedom is given significantly less weightage than what its true worth is. The bulk of secondary education seems to lay the focus on securing stellar grades, enrolling into a reputed college or university, and landing oneself a plum job.

Sure, this is a proven route; after all millions have embraced this approach and lived out their lives with considerable ‘success’.

But must working tirelessly day in and day out be the only route to this so-called destination called ‘success’? A large share of the ultra-wealthy did not work fixed hours at an office from a Monday to Friday and live it up on the weekends.

Rather, they followed financial discipline, spent less than what they earned, and made it a habit to invest regularly.

More importantly, investing is necessary to keep inflation from gnawing at our heels. The money that we have today is worth a little less tomorrow. Over months and years, it loses a large share of its value. In simple terms, our purchasing power goes down.

Understanding future value 

Girish’s phone was ringing. When he answered it, the shrill voice on the other side introduced herself.

“Good evening Mr Girish. I am Pratibha calling from Maa Lakshmi Lottery.”

The lady on the other end continued, “Congratulations! You have won the lottery. Your payout is INR10,000. You can either claim the whole amount today or take INR13,000 after three years.”

Girish, like most of us, could not believe his luck. He did not want to lose out INR3,000, but at the same time, he definitely wanted to lay claim to his winnings. Also, Girish had never made decisions so quickly.

He immediately asked, “Where should I come to collect the INR10,000?”

Girish then called his financial consultant friend, Priyanka, to reconfirm the rationality of his decision.

Priyanka diligently explained the concept and the calculation.

If INR10,000 was invested at 7 percent (the prevailing fixed deposit rate), Girish would be richer by INR700 (10000 X [7 ÷ 100] = 700) after a year. So his total amount would be INR10,700, considering we ignore taxation for ease of calculation.

This amount, when invested for another year, will yield INR749 ({10,000+700} X [7 ÷ 100] = 749), taking his total value to INR11,449.

The final amount, after two years, will generate INR801 ( { 10,700 + 749 } X [ 7 ÷ 100 ] = 801 ) in the next 365 days. The future value of INR10,000 after three years would have been INR12,250 ( 10,000 + 700 + 749 + 801 = 12,250 ) for Girish.

Mathematics classes from his childhood came to mind. Girish wished he had slowed down while taking the decision. An urge to seek instant gratification, and a botched calculation, had resulted in a loss of INR750 ( 13,000 – 12,250 = 750 ) for him.

At first glance, this may seem a minuscule amount. But it is these small amounts that go on to account for sizeable sums in future, thanks to the power of compounding.

The Economic Times reported in a 2017 article that INR1,00,000 in 1984 was worth only INR7,451 in 2016. During this duration of 32 years, the ‘termite’–called inflation–ate away the bulk of our savings.

Planning for children’s expenses 

Aside from advice on the lottery winnings, Priyanka also explained the impact of inflation on future goals, especially in terms of his child’s post graduation tuition fees. Girish’s 11-year-old wanted to pursue an MBA from IIM Ahmedabad in approximately seven years from when he’d won the lottery.

In the current scenario, a post graduation course sets one back by an average of INR20,00,000. In seven years, the value of this amount will have reduced by a significant margin. At the same time, the cost of tuition will have also increased. Come to think of it, the scenario is akin to a double edged sword.

Should Girish keep INR20,00,000 in his locker, it will not suffice when 2028 draws closer and his son is about to enroll at IIM-A. Assuming the cost of education will increase by 5 percent annually, the same course will total INR31,02,656 ( 2,000,000 X [ 1 + 5% ] ^ 9 ) seven years from now.

The locker money will have decreased in value over this time duration. To beat inflation, Girish must find credible investment avenues. If INR20,00,000 is invested in a fund that yields 5 percent annual returns, it will take care of Girish’s child’s post graduation expenses.

A more sound option would be to invest in an instrument that generates higher returns than the prevailing rate of inflation. So, if he derives 8 percent returns, he can invest INR15,52,101 ( 31,02,656 ÷ {[ 1 + 8% ] ^ 9 }) to ensure the IIM-A plans are not thwarted.

A disciplined approach

William Shakespeare said “Money is a good soldier, and will on.”

This soldier will work for us only when we understand the role time plays in determining the purchasing power of the rupee. We can turn the tide in our favour by adjusting our sails according to the direction of the ‘wind’.

At the same time, there will be temptations galore that prompt us to think we should first spend our hard earned money.

Songs like Johnny Kemp’s “Thank God it’s Friday night and I just-just-just-just-juuuuuuust got paid,” are a veiled attempt to loosen our purse strings and make frivolous purchases without any semblance of a plan.

The core idea must be to set out a clearly defined financial goal. This is an invaluable tool towards helping us align and fulfil our targets — be it children, marriage, healthcare or retirement related.

Following a disciplined approach will ensure we only shell out a predetermined sum for leisure or discretionary purchases. Personally, I advocate Dave Ramsey’s budgeting principle of “give every dollar a name”.

Hemant Kumar Agarwal

Hemant Kumar Agarwal, CFP(CM), is one of only 2000 certified financial planners in India. He loves to travel, play, read and educate. Hemant has conducted over 25 sessions, with participant sizes ranging from 20 to 200. He covers various aspects of financial planning, investments and income tax. On one occasion, Hemant even conducted a financial planning session for 150 youngsters at 5 am.

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