Picture this: You can take N1,000,000 now or wait a year and get N1,000,000. Which option would you select?
The answer may appear simple at first, but realising the time value of money can completely alter one’s outlook on financial matters. Let’s explain this economic notion in a way that’s applicable within the Nigerian context.
What is the time value of Money?
The Time Value of Money (TVM) is a fundamental principle in finance that acknowledges the idea that money’s worth changes over time. Simply put, $1,000 in your pocket today is more valuable than $1,000 a year from now. Why is that? Because money has the potential to earn returns or interest when invested wisely, it will be worth more in the future.
The Impact of Compounding and Cumulative Effects
Let’s talk about the secret sauce that accelerates your money over time: compounding. Returns on investment can be reinvested to produce a virtuous cycle of compounding returns. It’s like a snowball that, as it rolls downhill, takes up more snow and gains momentum.
If you put N100,000 in a savings account earning 10% interest per year, you’ll have N110,000 (N100,000 principal plus N10,000 interest) after a year. If you leave that N100,000 in the account for another year, you’ll earn interest on both the original N100,000 and the N10,000 in interest you accrued.
Do you see? That’s the power of compounding! Compounding increases wealth exponentially over time.
Now that we know what the Time Value of Money is, let’s look at some methods to put it to use for ourselves:
1. Start Saving Immediately: Get a head start by starting to save and invest as soon as possible. Investing even a little bit every month might add up to a significant sum over time.
Consider Amina and Bola, two close friends. When Amina turned 25, she began setting aside N5,000 every month, but Bola waited until she was 35 before doing the same. Even if they both earn 10% annually on their investments, Amina’s nest egg will be far larger than Bola’s by the time they are both 60 years old. Amina’s savings grew faster because of compound interest, indicating that those who invest early reap the greatest rewards.
2. Invest Regularly: Consider investing in equities, mutual funds, or real estate that can generate income for you over the long term. These investments typically produce returns that are above and beyond the rate of inflation, even though some of them are high-risk.
Let’s consider an industrious investor, Tunde. He decided to invest in a broad portfolio of stocks and bonds rather than keeping his money in a low-interest savings account. His investments generated an annualised 10% return over many years. The power of compounding means that Tunde’s initial investment will have more than doubled in value after 20 years. These sorts of long-term investments can serve as the basis for a secure financial future.
3. Leverage Compounding: Putting money aside on a regular basis allows you to take advantage of the compounding effect and grow your savings or investments over time. Set up an automatic savings plan, and don’t touch your savings unless absolutely necessary.
Meet Chioma, a hardworking expert who also happens to be frugal. Every month, she sets aside N20,000, which she then puts in a fund that yields 8% each year. Chioma’s nest egg will be worth more than N3 million after ten years of diligent saving and investment. She was able to secure a comfortable financial future because of her consistent savings and the power of compound interest.
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4. Recognise Inflation’s Effects: Keep in mind that the value of your money will decrease over time due to inflation. Pick investments with a higher rate of return than inflation to ensure that your purchasing power will grow over time. Meet Emeka, a man who prefers to keep his money out of harm’s way and in a mattress. The value of his money, however, is being slowly eaten away by inflation. Even though fifty thousand yen may seem like a lot now, it won’t buy as much in the future. Emeka decides to put some of his money in bonds and equities so that he may get a return that will keep up with inflation.
5. Diversify Your Portfolio: Spread your investments across several types of assets to lower your overall portfolio risk and increase your potential profits. You can protect your investments from unpredictable market swings by spreading them out.
Take Funmi, for example, a very diversified investor. She invests in a wide variety of businesses and markets across a number of nations. In this way, she can lessen the impact of a decline in a single industry or asset type. By spreading her investments out, Funmi is able to secure her fortune while still reaping the rewards of compound interest.
Understanding the time value of money is like having superpowers in the world of finance. You can make better choices regarding saving and investing if you have a good idea of how much your money could grow over time. Keep in mind that even a modest effort now can reap significant benefits later. So, get a head start, maintain your self-discipline, and watch as the power of compounding transforms your financial destiny. In Nigeria’s ever-changing economy, the time value of Money can help you chart a course towards financial stability and success.
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