In Chinese, there is a saying “寸金难买寸光阴”. It literally translates to “Time is more valuable than gold”. Can we really buy time with money? How do we put a value on time when time is an intangible asset?
Of course, we are not literally buying time, but we are talking about saving time instead. For example, if we hire some one to do some of our daily chores, such as doing house work, we are able to save a few hours in a day. The time we need not spend on the chores, is the time we buy. The amount we pay someone to do the chores for us is the cost of the time we bought. Every one of us is knowingly or unknowingly trading our time everyday. The employees spend their time doing things that their bosses do not wish to do with their own time. In return, the employees get paid with a predetermined amount of money – salary. The bosses who employ a lot of workers will be able to leverage the time of others to generate the income needed to pay the employees, and more income for themselves. This concept of time value is widely understood in modern society.
However, there is another concept of time value which is not commonly understood by layperson. It is often referred to as “Time Value of Money”.
Before we look into this concept of time value, let us understand some basic fundamental in calculating the future value of an asset.
If we have lump sum money of $10000 today, and it will appreciate 10% every year, how much will we have 5 years from now? Mathematically, we can use the following formula:
FV = PV(1+i)n,
Where FV is the Future Value, PV is the Present Value, i is the annual appreciation in percentage, and n is the number of years the asset appreciates.
Case study 1:
Dave has lump sum money of $10000. Starting this year, he plans to invest the money in an investment tool that returns 10% per year on average. The following will be the amount Dave has:
1 year later: $10000 (Present value) => $11000 (Future value)
2 years later: $10000 (Present value) => $12100 (Future value)
3 years later: $10000 (Present value) => $13310 (Future value)
20 years later: $10000 (Present value) => $67275 (Future value)
Case study 2:
John, like Dave, also has lump sum money of $10000. However, he decides not to invest the money until 10 years later because he wants to use this money on other commitments. If John delays investing the lump sum money of $10000 until the beginning of 11th year, how much will John get 20 years from now? (Assuming the return of investment is 10% per year)
Year 1 until year 10: No money is invested.
11 years later: $10000 (Present value) => $11000 (Future value)
12 years later: $10000 (Present value) => $12100 (Future value)
13 years later: $10000 (Present value) => $13310 (Future value)
20 years later: $10000 (Present value) => $25937 (Future value)
Based on Case Study 1 and Case Study 2, we combine both cash flows into one graph as shown below. It is obvious to us that by delaying 10 years, it will cost John $41338 in total investment return compare to Dave who starts his investment 10 years earlier than John. In another word, if John decides to start his investment now (like Dave), he may have extra $41338 after 20 years from now.
Compared to Dave, John will loose the opportunity to gain extra $41338 in the first 10 years . To John, 10 years time may worth $41338. However, here we do not discuss what John is going to do with his $10000 now. If he uses it to purchase a car for his own pleasure, then most probably the car will not appreciate or bring income to him. Then, the above comparison is a good projection. However, if he chooses to use the money to start a business (well, it is also a kind of investment), then the story will be different.
If you have $10000 to spend today, will you ever consider how many years it is equivalent to? Would you rather invest it to gain you a few extra years(to achieve early retirement), rather than spend it on purchases that does not give you long term benefits?
Labels: Investment, Saving