For church leaders to be more effective in seeking the “welfare of the city” (Jer. 29:7), we should know what economic concepts mean, how they should be applied, and how they affect the local church. The purpose of the Economics for Church Leaders series is not to present a theology of economics, but rather to provide a basic level of understanding that will help church leaders think more clearly about how to apply their faith commitments to economics and public policy.
Time value of money (TVM)
What It Means
Time value of money is the concept that because of potential earning capacity, money available now is worth more than the same amount at a future time.
Why It Matters
Would you rather receive $100 today or $100 one year in the future? You probably don’t have to consider the question too long before deciding you’d prefer the money today. But why is that true? Because even if you’re unfamiliar with the concept, you likely have an intuitive understanding of the time value of money.
Money is more valuable today than tomorrow for two reasons: inflation and interest.
CNN reported June 2 that prices are rising quickly across much of the developed world, with inflation surging to the highest rate since 2008. Inflation is the decline of purchasing power of a given currency over time, usually because of a general increase in prices. If prices rise 5 percent a year, then a dollar you earn today will only purchase 95 cents worth of the same goods and services a year from now. When the inflation rate is high and rising—as it is now—you are usually better off not only having the dollar today but also spending that dollar as soon as possible.
But what if there is nothing you want to spend it on this year? That’s where the second factor—interest—comes in. Some people are willing to pay you in the future for the dollar you loan them today. They either believe they can use the money to earn more money (buying a car so they can become an Uber driver) or they are willing to sacrifice future money to purchase something they want today (a mortgage on a home).
Here’s why interest makes money now even more valuable than in the future. Let’s say the simple interest rate is 10 percent a year, which means someone is willing to pay 10 cents a year for every dollar you loan. If I borrow $100 from you at 10 percent a year, then next year you’ll have $110. (If the inflation rate is 5 percent, then your purchasing power is reduced to $105, which is still $5 more than it would have been.) Therefore, if someone gives you $100 today you can loan that money out and earn $110—$10 more than if you had waited to accept the gift next year.
In Matthew 25:26–27, Jesus tells a parable about talents that relies on an understanding of the time value of money. At the end of the parable, Jesus says,
But his master answered him, “You wicked and slothful servant! You knew that I reap where I have not sown and gather where I scattered no seed? Then you ought to have invested my money with the bankers, and at my coming I should have received what was my own with interest.” (emphasis added)
While this parable is about the kingdom of God and not about investing, the story does provide a useful framework for financial stewardship. If we are responsible stewards of the disposable income we have today, we will consider whether it is better to save and invest our extra resources to create more wealth that can be used for God’s purposes in the future. We will also be concerned about the effect of inflation, since it tends to harm the poor and those without tangible assets, like property or stocks. Because of inflation, it can become more expensive to be poor.
Americans tend to overestimate the inflation rate.
We gain a better understanding of the time value of money—and can make more prudent decisions about the future value of money—when we understand the inflation rate. But many of us who lived through periods of high inflation tend to overestimate the year-to-year rates of inflation.
For example, many people tend to estimate the current annual inflation rate as 4 percent or higher. But until May, when it reached 4.2 percent, it hasn’t been that high since 2007, when it was 4.1 percent. From 2012 to 2020, the rate ranged from a low of 0.7 percent in 2015 to a high of 2.3 percent in 2019. By overestimating the inflation rate, we may underestimate how much the recent spike to 4.2 percent will affect us and our neighbors, both nationally and globally.
How to calculate the TVM.
There is a basic formula that can help you calculate the time value of money. The variables you need for the calculation are:
FV = Future value of money
PV = Present value of money
i = interest rate
n = number of compounding periods per year
t = number of years
Based on these variables, the formula for TVM is:
FV = PV x (1 + (i / n)) ^ (n x t)
For example, if we invest $10,000 for one year at 10 percent interest the future value of that money is:
FV = $10,000 x (1 + (10% / 1) ^ (1 x 1) = $11,000
We can also use these variable to find the value of the future sum in current dollars. For example, the value of $5,000 one year from today, compounded at 7 percent interest:
PV = $5,000 / (1 + (7% / 1) ^ (1 x 1) = $4,673
You can use an online financial calculator to make the calculation easier.
Using Uncle Sam as a savings account.
Earlier we noted that people tend to prefer money today to money in the future. There is one especially noteworthy exception: tax refunds.
Let’s say you receive a tax refund of $1,200. That would mean you paid about $100 more in taxes every month than you needed to cover your tax payment. Instead of receiving that $100 every month and saving it (thereby earning interest), you are loaning the federal government that money at a zero percent rate and asking it to return the money to you after April 15 the next year.
Is it rational or prudent for people to give interest-free loans to the government every month? Probably not. But some people do it as a type of forced savings plan. Because they do not believe they are disciplined enough to save small amounts every month (and earn the interest), they give it to the government to hold for them.