Why does the money received today have more value than that of tomorrow?

Introduction: A Daily Decision

Imagine your boss offers you a raise of 1,000 USD now or to wait six months to receive 1,100 USD. Which would you choose? Although it seems simple, behind this decision is a fundamental economic principle: the time value of money (TVM). This concept is neither new nor complicated, it just requires understanding how time affects purchasing power and investment opportunities.

The fundamental principle of the TVM

The value of money over time states that a certain amount of money today is worth more than the same amount in the future. Why? Because with money in your hand now, you have immediate options: you can invest it, deposit it in a savings account with interest, or use it for any opportunity that arises. By waiting, you lose all those possibilities, which is known as opportunity cost.

Let's go back to the example of your friend who owes you 1,000 USD. He proposes to pay you today if you go to get it, but in 12 months he will give it to you without you having to go. If you wait a year, not only do you lose the chance to use that money immediately, but also inflation will have reduced its purchasing power. With the money today, you could invest it in a fixed-term deposit or in other assets that generate profits for you during those 12 months.

Calculating the future: How much will your money be worth tomorrow?

To make smart financial decisions, we need to go beyond intuition. The future value (FV) allows us to calculate exactly how much a sum of money can grow if we invest it today.

Suppose you invest 1,000 USD at an annual interest rate of 2%. After one year you would have:

FV = 1,000 USD × 1.02 = 1,020 USD

If you wait two years with the same rate:

FV = 1,000 USD × 1.02² = 1,040.40 USD

The general formula is:

FV = I × (1 + r)ⁿ

Where: I is your initial investment, r is the annual interest rate, and n is the number of years. With this calculation, you know exactly how much your friend should pay you to make it worth the wait. If they only offer you 1,020 USD after a year, you are barely covering the missed opportunity. If they offer you 1,040 USD or more, then it is worth the wait.

Understanding Present Value: What is a Future Promise Worth Today?

The inverse concept is equally important. The present value (PV) helps you determine how much a sum you will receive in the future is really worth today. This is especially useful when evaluating investments or financial agreements.

Your friend changes his offer: instead of 1,000 USD, he will give you 1,030 USD in a year. Is it a good deal? Use the present value formula to find out:

PV = 1,030 USD ÷ 1.02 = 1,009.80 USD

The calculation reveals that this future promise is equivalent to 1,009.80 USD today, which is almost 10 USD more than you would receive if you got the money now. In this case, waiting makes sense.

The general formula for the present value is:

PV = FV ÷ (1 + r)ⁿ

Here you can see how present value and future value are two sides of the same coin, allowing you to convert future money into its current equivalent.

The magic of compound interest

Where things get interesting is with compound interest. While simple interest is calculated once, compound interest is calculated on the initial principal plus the accumulated interest. It's like a snowball that grows exponentially over time.

If your money is compounded four times a year instead of just once, the outcome changes:

FV = 1,000 USD × (1 + 0.02÷4)⁴ = 1,020.15 USD

It seems like an insignificant increase of 15 cents, but in large investments over long periods, this difference multiplies dramatically. Here is the true magic of letting your money work over time.

The factor that no one considers: inflation

There is a silent problem that erodes the value of your money: inflation. If the inflation rate is 3% per year and your investment only generates 2%, you are actually losing purchasing power. What you could buy today with 1,000 USD will cost more in the future.

That is why in times of high inflation, the TVM calculations are adjusted to include the inflation rate. Although inflation is difficult to predict accurately, including it in your analyses gives you a more realistic view of your real earnings. Inflation also varies by country and the index used, which further complicates the calculations.

Applying the TVM in the crypto world

TVM decisions are not just theoretical; they are very practical in the cryptocurrency universe. When you consider the locked staking of ethereum (ETH), you face exactly this question: do I keep my ETH today or lock them for six months in exchange for an interest rate of 2%?

You can compare different staking opportunities using the same principles. If one platform offers 2% and another 3.5%, present value calculations help you determine which one is actually better considering the lock-in time and associated risk.

With bitcoin (BTC), the situation is more complex. Although it is theoretically considered deflationary, its supply actually gradually increases until it reaches its limit of 21 million. This creates inflation in the short term. So, should you buy 50 USD of BTC today or wait for your next paycheck? The TVM would suggest buying today, but the price volatility of BTC adds a variable that basic formulas do not take into account.

Smarter financial decisions

You have probably been using the TVM intuitively without realizing it. Every time you compare whether to wait for a greater increase or take it now, you are thinking in terms of the time value of money. Every time you decide to invest instead of keeping money under the mattress, you acknowledge the power of compound interest.

Large corporations and professional investors live by these calculations. For them, even fractions of a percentage represent millions in profits. As a crypto investor, formally understanding these concepts gives you an edge when deciding where and when to invest your money to maximize returns.

The next time you face a decision between money now or money later, remember that it’s not just about the amount, but also about the time, interest rates, inflation, and all the opportunities you lose or gain along the way.