Time Value of Money & Compounding Math
The Time Value of Money (TVM) is the core foundation of finance. It states that a sum of money in hand today has a higher purchasing value than the identical sum in the future due to inflation and earning potential.
Key TVM Formulas Simplified
1. Future Value (FV)
FV = PV * (1 + r)^n
Where:
- PV = Present Value
- r = Annual Return Rate
- n = Number of Years
2. Rule of 72
To estimate how many years it takes for your money to double at a given annual return rate (r):
Years to Double = 72 / r
Example: At a 12% annual return, your money doubles in approximately 72 / 12 = 6 years.
Lessons for Investors
- Start Early: A 5-year headstart in your 20s can produce a significantly larger final corpus than starting in your 30s with double the monthly contribution.
- Account for Inflation: Always calculate future expenses in real inflation-adjusted terms.