What is the time value of money?

The time value of money is a fundamental concept in finance that asserts that a specific amount of money today has greater value than the same amount in the future. This is due to the potential earning capacity of money; money can earn interest over time, which means that if you invest or save a dollar today, it will grow to more than a dollar in the future.

This principle is rooted in the idea of opportunity cost. For instance, if you have $100 today and you choose to invest it at an interest rate of 5% per year, you will have $105 a year from now. If you receive that same $100 a year from now, it misses out on potential investment returns, resulting in a lower value compared to the present-day amount. Therefore, understanding this principle helps individuals and businesses make informed decisions regarding investments, savings, and consumption over time.

In contrast, the other options suggest incorrect or incomplete interpretations of the time value of money concept. Some mention degrading value without linking it to the earning potential, which misses the essential crux of how money functions over time in financial contexts.