Susan O’Mara: The time value of money

by | Oct 29, 2021

When writing a piece for the Top 50 edition of the Construction magazine, I always try to find a way to link my piece with the number 50. My colleagues in the Construction Executive Savings Scheme (CERS), celebrate the scheme’s 50th anniversary this year.

It made me think about time and money, that is to say, the time value of money. Having a basic understanding of the effect of time on money is important to understand as it impacts how you structure your personal finances and impacts the decisions you make.

Why is the time value of money important?

50 years ago, the Irish Times cost 6p! From here on in, I will switch to the Dollar; as there is no currency change as we look back over 50 years (from Punts to Euro). As a small child in 1971, if you were given a crisp $100 from your uncle, (the fancy one who had been to America) and you kept it safe under your mattress ever since.

All these years later you would, of course, still have $100. Furthermore, you would have saved the cost of any charges associated with investing your $100. Win win!

When money does not equal value

While the crisp note might be $100, the value is something else entirely. The actual value of your $100 from 1971 is now the equivalent of receiving a gift of $663 in today’s terms. Inflation has eroded the value of the dollar and now you would need significantly more money to match the purchasing power of the $100 you had 50 years ago.

Banks understand this, this is why when they give you a long-term loan such as a mortgage, they are very specific about the amount of interest you must pay on the loan and their right to adjust it. They want to ensure not only that they make a profit, but that in 15 years or 30 years the payments you are making reflect the current value of the loan.

Serious investors understand this. People invest in the stock market, not only for their money to grow, but to ensure it outgrows inflation over time.

Pension schemes understand this. Saving for retirement usually spans a 40-year period, and so, in order to grow your money above inflation, you need good returns. You are unlikely to find a Defined Contribution pension scheme that will default you into a low risk investment strategy.

This is due to the diminishing purchasing power over an extended period. In conclusion, over time, the effect of inflation reduces the value of your money. It reduces its purchasing power and you get “less bang for your buck”. To ignore this point is to lose money even if your capital amount remains intact. While it’s true that time steals value from our money, it repays us in another way by reducing investment market risk over the long term. The longer you remain invested in a share or index of shares, the better the odds of earning a positive return.

For example, if you invested in the S&P 500 Index on 7 September 2001, your money would have grown by +217.48% (This converts to an annualised performance of 5.95%) by 7 September 2021. However, within that period, you would have seen the worst year returning -35.3% in 2008 and the best performing +31.25% in 2019 – with many varied returns over the 20-year period.

What should you do now?

Consider the value of time on your money. Invest cash wisely, take an appropriate amount of investment risk in your pension, and inflation proof your savings, by investing them in funds rather than a low or no interest paying bank account.

And remember…

Time Marches on; bring your money with you.

Susan O’Mara

 

For further information contact Susan O’Mara in Milestone Advisory via email on [email protected] or phone +353 1 406 8020.

Milestone Advisory DAC t/a Milestone Advisory is regulated by the Central Bank of Ireland.

 

Warning: The value of your investment may go down as well as up.

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