The Time Value Of Money When Making Financial Decisions

Life is about making timely decisions, this when it comes to your personal life, job, or your business. What’s often ignored is the interplay that exists between these entities, and the fact a bit of interdisciplinary thinking can go a long way.

This however, may sound too obtuse to some.

When making major life decisions, the key becomes thinking a bit radically, while remaining grounded. Business is all about creating value.

Our personal lives this according to economists, is all about maximizing our utility. What utility means in this case, is a measure of satisfaction gained from a good or a service.

When it comes to businesses, owners, investors, and its shareholders, they should be able to create more value by themselves using other means.

Otherwise, there’s no point for anyone to operate or invest in a business.

Assuming we don’t have a perpetual income stream, a passive income money tree spewing out cash, it comes down to this.

If you don’t bother creating value in today’s economy, you’ll either be forced to alter how you do things, or cease to exist.

The Value That Is Time

Individuals have it a little easier in most cases than businesses. Creating maximum utility is an incentive in and of itself.

In the end, all we want is more, whether it’s revenue and growth for our business, or increased utility in our personal lives.

To get more, the decisions we make, does is have a direct impact on both value creation and utility maximization. This particularly when it comes to finance.

Successful strategic management for business, is supported by your investment policy, along with your financial policy.

Linked to all of this is risk management. How you handle the in and outs, the hazards that are associated with these financial decisions.

Personal financial decisions influences your quality of life, and your ability to enjoy the things you want.

What this involves is the study of incentives, which is how people get what they want, or need.

This especially when others want or need the same thing. In this case, maximum utility.


The Time Value Of Money

One of the cornerstones when it comes to finance, is understanding the proper decisions to make. This is equally applicable when it comes to business and personal finance.

This is known as the time value of money. Receiving $100 today, is worth more to you than $100 received in the future.

The reason for this, is because money has time value, such generating interest, regardless of how measly it may be.

The income that’s generated from the investment will in turn, make the hundred dollars you get today, worth more than what’s promised to you in the future.

For instance, Sarah is offered the choice of receiving $1000 now, or the same $1000 in a year’s time.

She takes the cash now, and invests it in a security that yields 8% percent interest.

A year from now she has generated $1080, which is more than if she deferred taking the $1000 in the future.

It’s All About Incentives

This comes back to incentives. Banks pay interest rates because they can use your money now, and they’re prepared to pay you a return for the privilege of doing so.

What they’re doing in fact, is paying a premium, for taking the risk of lending your money to someone else.

When it comes to business, this concept is part of what’s known as the Sharpe-Lintner Capital Asset Pricing Model, or CAPM.

What this formula does is allows individuals to calculate, this in today’s terms, the value of future cash flow of any project or decision, that requires an investment.

There’s another side to this, which is slightly more personal. The time value of money, can apply to you personally. Specifically, your utility.

To understand how this can occur, things need to be viewed inverted, to get a handle on the incentives of everyone who’s involved.

Looking At Personal Incentives

Think of a large personal asset you own, such as a structured settlement. The agreement that’s reached in setting up the settlement, was it left up to you with a sense of security for the future.

Did you also agree to receive guaranteed consistent payments over time.

The illusion is, you’ll be better off in the future with the settlement. The problem is, they don’t want you to have all your money right now.

What they understand is the time value of money. So what they’re “banking” on, is the hopes you haven’t given it a second thought.

Structured Settlements

Keep in mind structured settlements are designed, so the bank in this case, gets the maximum benefit from the time value of money.

This isn’t an accident, or because of an act of benevolence that’s driven by concern regarding your long term well-being.

To some, it’s a pure marketing and negotiating ploy.

Considering the time value of your settlement, the incentive is for them to keep your money as long as possible, this to maximize their value growth.

The Growth Of Money

Consider the time value of money in your personal life. How much value is there for you, in holding a first mortgage on a property for 20 years, compared to maximizing your utility.

How much utility, is your monthly settlement check going to provide you in 10 years? Just think about the increases in the cost of living over that time, and how that monthly check holds up.

Whether in business or your personal life, always consult with a diverse range of industry professionals to increase your information and knowledge, to make the proper decision.

Risk management is an important part of any decision making process. Keep in mind the time value that is money, as it can be used both for and against you.