Time Value of Money – Explained – Episode 406

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[00:02] We’re going to be talking about the time value of money. And that might sound like a strange or weird concept. I promise by the end of this episode, you’re going to look at money different and how your money is spent and invested. Is that a decent promise we can hold Kim? It is Spencer and it’s such a fun one because it’s such an impactful thing. Yet one of those stealth concepts that kind of lurks in the background that we’re not really aware of. And then even when we become aware of it, it recedes into the background again and we forget it. Perhaps you can set the stage because time value of money isn’t one of those dinner table conversations that most people have or a vernacular that sits

[00:51] with them. Can you unpack and explain what it means first? You mean it’s not like, hi, nice to meet you. What is your time value of money? It doesn’t work that way. You know, I tried that on the first dates and for some reason it just didn’t stick. That’s a stretch. I thought mine was bad. All right. So the time value of money is one of those concepts that’s kind of like the law of gravity. You could even say it would be like the law of capitalism, but we’ll stay away from that one just because of the political connotations that it brings up. So the law of gravity, you know, we do forget sometimes, right? We’re out and we’re like, oh, this would be a fun wall to jump off of. Oh, my gosh, that was a little higher than I thought.

[01:46] I forgot my body went down that quickly. And the law of gravity, we see an operation all the time, but it recedes in the background, right? We don’t think about it. We don’t talk about it really very often. Time value of money is the same way because we forget that money and our lives exist in time, literally. And I’ll just use a 24 hour period for reasonableness. Once we go past one day, one dollar is impacted by the time value of money. And I’m starting at a really high level here, especially for those that are maybe newer to the money game, just starting to learn about finances, which, holy cow, sometimes people are in their 50s and 60s when that happens. Sometimes maybe they’re just right out of school. And I find that

[02:37] time value of money probably was taught in elementary, maybe for sure middle school and high school and college, but it does not have any meaning to us unless we’re operating in the world of finance. And I don’t even mean high finance, just the basic personal financial space that really takes being probably out of school and living on your own and having to make decisions around personal financial matters, where this time value of money really plays a role. But I want to tell a story first. And that story is that for those of you that are old enough to remember when you as a child might have stood up in the front seat of a car, driving down the road, perfectly legal with your parents, obeying all the laws that existed in Are you ready for

[03:39] this? The 1970s, right? I don’t know. Maybe you know, Spencer, when when did seatbelt laws come into play? Do we know that era? I would say 80s maybe, but exactly. Yeah, not that long ago. So if you’re a five year old, six year old old enough to remember your childhood, in the 1970s, you stood in the front of a car in the front seat of a car completely legally, policemen could drive by they would think nothing of it. If the parent driving that car had to stop the car, they quickly they would reach out their arm in front of you as if that would make a big difference in stopping your body from being a projectile. And it was completely common. Well, fast forward to today, the parent would get put in jail if

[04:29] they had a five year old riding in the front seat of a car period, much less standing up. And so that’s an example of something that’s taken out of time. And so that’s the storyline. Now, how does this relate to money? Well, we can think about the time value of money. Also, as it relates to the passing of time, including literally just the beginning 124 hour period impacts the time value of money? How? Well, one of the ways is something that is fairly well known, which is inflation. And we all have been around when our parents or grandparents said, Oh, my gosh, I used to buy some things and it’s not across the landscape because of what technology does. But there are definitely some things I used to buy that for what you

[05:23] know, let’s make something up. I used to buy a gallon of milk for $1, a gallon of milk is now $4 or whatever the price is. I used to buy a house like a beginner house for, you know, pick your number $50,000. Now a beginner house is $100,000. Those types of things are affected by inflation. And inflation is an aspect of the time value of money. What we have to remember in learning about personal finances is that absolutely positively everything is affected by the time value of money. And it’s super easy to forget about it. I am involved with my husband Todd Langford, who teaches truth concept software, which is a heavy duty calculator system that financial advisors use. And you have people 30 and 40 years in the financial

[06:18] advising business that forget about the time value of money. I have looked at equations and forgotten about the time value of money. And I think on another podcast, we share some specific examples of where it is forgotten and what to do about it. Today, we’re trying to just stay at a higher level and introduce the concept. I’ve shared my perspective on it to initiate the conversation. Spencer, jump in. You are not in the personal financial industry, but you’ve got a good head on your shoulders. How would you explain time value of money? You know, yeah, I’m getting put on the spot. And immediately, I think of, yes, inflation. But I also think of time value of money being a, a, call it a friction point for people that

[07:16] didn’t learn when they should have or they’re, or they’re filling the pressure to learn too rapidly. And so what that means, typically, and this is just from conversation I’ve had, it’s people could be in 40s, sometimes 50s, and they’re looking at the the runway they have left with their career. And they’re saying, I wish I would have done fill in the blank. And that’s what the time value of money conversations have to me, and that’s where they’ve gone. And on top of that, it’s looking at the landscape of speaking, you know, just here in America right now, seeing the real estate industry be completely out of whack, see the the interest rates be something that we can’t even relate to. And then the inflation that’s creeping up

[08:15] and silently killing a lot of people. That’s where this time value of money of conversation has really made an impact to me. And so I, you know, as part of this conversation, it’s not only something that listeners have requested to learn more about time value of money, but it’s something that I’m looking at, because I have young kids in the house. And I’m talking with them and I say, Okay, well, you have this checking account, a savings account, and they have, you know, multiple savings accounts. And I’m going to use the example of my son, Zane, who, you know, he’s got into drones, and he’s been spending a lot of money on it. And that’s a lot of yards he’s had to mow. And that’s difficult. And he finally came to me a

[09:02] couple weeks ago, and he goes, Dad, I buy in these drones, but now I watch I build my bank account up and then it’s gone. And I have to do something that’s going to continually bring in money, and something that is going to continue to increase, because this is just going to cost more and more. And I’m never going to win this game. It’s a 14 year old. Yeah, so amazing. So what’s interesting about money is that it has to exist in time. And once we get past one day, money goes from just the dollar to being affected or impacted by an interest rate. So an interest rate is how we measure time value of money. An interest rate is how we measure inflation. An interest rate is how you brought it up. We compare

[10:02] loans. So we have real estate mortgages, for example, right now, primary residence mortgages, investment real estate mortgages at a crazy low interest rate. And that aspect, that interest rate of money is how we measure, compare, identify, transact. That interest rate or an interest rate has to be applied to a dollar all the time. In other words, if you go over time, and you have say a dollar a day, the dollar is not just safe for five days, five dollars. It’s impacted by the time value of money. Now, clearly over five days, that’s going to be minuscule. But over 30 days or over 30 years, it’s massive. And it’s really easy when we’re looking at all kinds of different financial transactions to want to just

[10:59] add up the dollars and to forget about the time value of money. So that’s on the plus side, like what Zayn is saying, like, how do I get my account to build in a way so that it keeps building and it builds on its own? And that’s a function of time value of money. And then the mortgage on again, primary residence or investment is almost a reverse time value of money function. And it’s called an amortization schedule. And it’s where you have, let’s just say, a million dollar mortgage or $100,000 mortgage, the zeros don’t really matter. And you have a particular interest rate. And that interest rate is applied to the principal. And that X dollar mortgage is working down or backwards. That’s an amortization schedule.

[11:47] And that’s another example of time value of money. And it’s so sad to me. In fact, Todd and I have recently looked at a mortgage for a particular transaction that we were going to do. And the quote, truth in lending statement, the TIL statement that all banks are required to provide with your mortgage is so misleading. And so I’m going to call it wrong because of the words that they combine with some of the numbers that they put forth. It’s very, very disheartening. And it makes Todd and I want to just continue to do the work that we’re doing because people don’t have the financial education around time value of money that they should. And so it causes the banks to try to explain it better. But in their

[12:36] effort, they’ve actually, I think, caused more confusion. And they will say things like this $100,000 mortgage that you’re signing is going to take $300,000 to pay it back with all the interest. Well, yes, that’s accurate. But again, they they don’t play that out over time with the time value of money and of course, the tax deduction and everything else. And by the way, if you want a little bit more knowledge around this, we have a book called Busting the Interest Rate Lies. There’s an audio version, there’s a physical version, and there’s a Kindle version. And it goes through all the time value of money transactions, as well as the mortgage discussion, etc, etc. And it shows an amortization schedule. You know,

[13:15] that’s just, again, that’s just not something that’s taught. People don’t even know how to look in an amortization schedule. And they’ll hear things like the difference between simple interest and compound interest. Well, simple interest is typically thought of as a particular interest rate applied to a particular dollar figure, and then stopped. And simple interest is accurate for one day. But as soon as you get past one day, it becomes compound interest because now you have the dollar plus the interest and that entire so let’s call it $1.05 that entire thing has interest applied to it. That’s compound interest, interest on interest. In fact, I’m going to quote this wrong, but Albert Einstein somewhere has the

[14:05] compound his one of his famous quotes, the compounding of numbers is the eighth wonder of the world or something like that. And it and it works both forward and backward, if you will, in other words, building an account as well as dealing with a loan. And in the probably back in the 70s, to pick up on our story, then there actually used to be things that the banks could do to play with that a little bit. And they could actually have simple interest loans, etc. But in today’s world, any loan I’ve ever seen, whether it’s at a life insurance company, if somebody is borrowing against cash value, or if it’s a bank loan, where somebody is borrowing against a piece of real estate, or any other transaction like

[14:48] that, that I’ve ever, ever seen its compound interest. And there’s a lot of people out there that talk about, for example, life insurance loans being simple interest bank loans being compound interest. That’s not accurate. A life insurance loan is simple interest to once it gets passed one day because of the time value of money. You know, you you said something in your statement that I think may accelerate and we’re gonna we may even get to see this, obviously in our generation, but maybe much sooner. You were talking about money. And oftentimes, we you know, we see the let’s say on a daily basis, we can’t really see the difference. We can’t go from Monday to Tuesday and see the change in the value of the

[15:34] dollar. Because, you know, call this frogs boiling, you know, the water’s rising and rising. But then I thought, there’s actually one place, and there’s one mechanism that could change all of this. And that is Bitcoin and cryptocurrency. And right now, you can actually see those markets fluctuate by more than 10% in a day. And so that is almost a wake up call to seeing what can happen to capital by not respecting and understanding time value of money. Now, there’s FOMO to that. But still, I think that is if that decentralized type of currency happens, the world’s going to wake up and realize our banks are lulling us into not being conscious of time value of money because the interest rates are so low. They’re hidden. You

[16:29] can’t you know, your sweet son with his savings account. He’s not even earning anything at a bank. And it breaks my heart when I hear that because it’s so frustrating. It actually makes people turn to things like the cryptos, I think too quickly. And I love the cryptos. They’re a fabulous space. I can’t wait until we can operate on them fully, which you know, hopefully we’ll see that in our lifetimes, who knows. And yet at the same time, you’ve got a need or us as a society, we have a need to store liquid cash in a place where it isn’t going to fluctuate by 10% in one day. And so this is a tough space for a lot of people and a lot of our listeners know that we use cash value of life insurance

[17:14] as a go between or an in between, I should say, for solving this problem. And so that’s nice and handy. But the fact is, a lot of people are lulled into not understanding time value money, because so hard to see with bank accounts, savings accounts, money markets, even any type of bond or liquid account. Again, putting all of that in one category, whereas crypto in my mind would be more of an investment orientation, not a liquid savings based type of account. And it’ll be interesting to see as time progresses, whether there are subsets of the cryptos that act more like a cash account where they’re stable, and then others that continue on the roller coaster ride of investing. Yeah, there. We’ll see if it

[18:04] gets there. It’s a it’s a crazy roller coaster right now. You know, I think probably a great call to action or next step. Again, as you mentioned, busting interest rate lies is a wonderful book. And then I think another to go deeper for families that are, you know, investing in, you know, additional rental income properties or businesses, whatever that may be, is looking at the truth concepts calculator, because there’s so many misconceptions. And I, you know, I have friends that are financially just brilliant. And they’ll sit there and they’ll go, Oh, 15 year mortgage is the way to go all the time. And I go, maybe you want to run it through this calculator here. And, and you actually see what time value

[18:51] has to this equation. And so that’s truth concepts.com. That’s one I would suggest. Absolutely. And I think any financial calculator can help with this. The challenge is they’re tough to learn. So the standard in the industry is that HP 12 C that’s on reverse Polish notation. We talk about some of this on the other podcast and Spencer, maybe you can find that other one and link these two in the show notes, because the HP 12 C, which I learned a long time ago, I’m not even sure I could use anymore is enabling somebody to understand time value of money because of the financial functions that it operates with. And there are others, there’s a Texas instrument, equivalent, etc, etc. One of the nice things

[19:39] about the truth concepts calculators, and they’re primarily going to be for people in the financial industry. Nevertheless, anybody can download the suite of calculators free for 10 days. And the five financial functions of a financial calculator are on there in super simple calculator format where you can see all the numbers. And it’s not in reverse Polish notation. And that’s a real thing. When I first heard Todd talking about that, I thought, is he kidding? Like, reverse Polish what? Well, that’s a real thing. So as we wrap up here, the five functions of personal finance, and of course, corporate finance as well, our present value, future value, time payment. And then the last one is rate and rate is especially

[20:37] tricky because it is there’s not a formula to figure out rate. Whereas those other four are all interrelated. Rate is actually done with guesses and the calculator or the computer or your phone if you happen to have a financial calculator on your phone goes back and forth in something called iteration and guesses a rate until it gets close. But time, payment, present value and future value are all calculatable and interrelated formulaic numbers that then create an answer for whatever it is that you’re looking for the payment, the present value, the future value or the timeframe. And just as we got done talking about time value money, the time calculator of the one of the five is actually the one that we

[21:26] use the least yet with present value and future value, obviously, you’re incorporating time. And even with payment, you can’t figure out a payment if you don’t know the timeframe over which that either growth of account or amortization of alone is occurring, you have to have time to figure that out. And then, of course, time is figuring it out how long if I’m if I have $10,000 and I’m adding 1000 a month how and I have a particular interest rate. So you have to have that too. How long is it going to take me to get to whatever future value I want to get? So of these five things, you have to identify four of them in order to figure out the fifth. And one of the numbers can be zero. And that throws people sometimes also,

[22:15] you might have zero payments or you might have $0 to begin with like zero present value, or maybe you want zero future value, like if you are trying to pay down alone. So these are all aspects of that time value of money, the larger landscape, if you will, of doing any type of calculating around personal finance. And I would put it this way. If you’re trying to figure out something in the personal financial arena, don’t use a regular calculator. Using a regular calculator, unless you’re just adding well, if I have $3 and I add $3 to it, what am I going to have $6? That’s fine. But anything else you should figure out a way to use a financial calculator, whether you use the truth concept software, or you get an HP

[23:03] 12 C or a Texas instrument or some other thing on your phone, whereby you can make appropriate and complete IE using all five elements, calculations for whatever it is that you’re trying to calculate money in the future payment, timeframe, interest rate, or future present value, and the present value is a toughie. Just a quick example on that. If you have $1 million in the future, and you’re trying to figure out what that would feel like today at a particular interest rate, that’s what present value is for it’s probably one of the least used ones also, but it’s a really handy one around death benefits. Like if you have a million dollar life insurance policy, but you’re and you know, it’s going

[23:51] to be that in the future. But you’re trying to figure out if the death occurred today, that’s what present value is used for you know, it’s interesting, we started out at a very basic level of this. And what’s nice is you gradually weave in stories and principles and pieces to take us to a higher level to understand that any type of financial decisions with even minimum complexity should really be looked at with these elements. So this was helpful. It’s a joy to do and with full credit to Todd, I would not have this knowledge if I hadn’t attended so many of the truth trainings, which is where he teaches financial advisors and others all of these personal financial concepts. In fact, one of the advisors likened it

[24:38] to a PhD in personal finance. That’s good. We’ll make sure to put a link to truth concepts inside the show notes. Again, that’s truth concepts.com. And you listeners have additional questions or maybe, you know, you’re looking to figure out what some unknown factors are in your financial future. You can always send an email to hello at partners for prosperity.com and Kim’s able to answer those or someone on the team can help you out. Thank you for listening to the Prosperity podcast to take control of your money and have it work for you. Visit us at partners for prosperity.com If you liked this episode, make sure you subscribe and leave a review.