Understanding The Time Value of Money

Let's suppose you go shopping for a piece of very sophisticated exercise equipment. You find the one you like, and the dealer offers you this choice:

Which of these two options would you choose?


* Price today of $4,000

* 36 year full parts and labor warranty

* All your money back - $4,000 - at the end of the warranty period.

OR:

* Price today of $3,000

* 36 year full parts and labor warranty.

* $0 rebate at the end of the warranty period.


Would you rather pay less today and get no rebate, or let the dealer use your money for 36 years and get 100% of your money back?


Answer:


The exercise equipment dealer can invest the $1,000 difference today and let the compounding of interest work for him/her instead of for you.

Suppose instead that you have that extra $1,000 and the self-discipline to invest it in something that earns a 12% yield. $1,000 invested at 12% will grow to $64,000 in 36 years.

If instead, you gave that $1,000 to the exercise equipment dealer, in 36 years, he could rebate your full purchase price of $4,000 and keep a (hypothetical) profit of $60,000 for himself.

The REAL Question any investor should be asking him(her)self is this:

With the same $1,000 and the same 36 years, why would you want someone else to have your $60,000?

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