The Time Value of Money

I sometimes think that one of the most important lessons a young person can learn is that $1 today is worth more than $1 tomorrow. It is amazing to observe that many young adults don’t learn this, one of the most critical principles of finance, until they reach university. My goal with this post is to make it easy to understand why money today, this month, or this year is worth more than money in the future.

Why is money today worth more than money tomorrow?

Simply put, because money can earn interest (and have less purchasing power due to inflation).  If I receive $100 today and can earn 5% interest annually, my money is worth $105 is one year. $105 a year from now is worth exactly the same as $100 right now for me as an investor. That being said $100 today is worth more than $104.99 in a year from now.

Why is this important? 

Making personal financial decisions is something that we have to do every day. If we know that it is better to pay in the future (because money is worth less at that time) then we would surely take advantage of times where people let us pay later rather than now. My favorite example of this is a car loan. Many car dealerships will offer you 0% or a very low interest rate to incentivize you to buy a vehicle from them. If you had $10,000 to pay for the car outright, is it still better to finance it? Yes! Simple math can show you that if you have no borrowing cost, but can earn interest that your $10,000 car could cost you much less!

You could pay $10,000 today for that vehicle, or you could pay $275 a month (for example) for 3 years and pay off the car. If you take time to pay off the car, your cash that would have been used to pay the whole balance can be in an investment earning you 5%. After one year, you will have paid $3,300, and used the remaining $6,700 to earn you $340 in interest, making the care effectively cheaper.

This principle is one of the fundamentals of financial theory and will affect the way that we calculate the value of things today versus in the future. There is a formula which can be used to describe the relationship between dollars today and dollars tomorrow. It is shown below.

PV = Present Value (value today)

FV = Future Value (value after one period)

r = The discount rate for the period (interest rate with or without inflation included)


Why Use A Mortgage Broker

I passed my mortgage agent’s license in December of last year and have been talking with my friends and family about what I do and it surprised me to learn that not a lot of people actually know what a mortgage broker does or why they should use one. If there is one thing you can take from this post it is this. If you are seeking out real-estate backed credit (e.g. mortgage for any reason) you MUST talk to a mortgage broker. But why?

  • We ask the right questions

Arranging mortgages all day can be a tough job, but it hardens us mortgage agents into financial fighters, credit combatants, money mercenaries, you get the point. We have extensive knowledge of the many different mortgage solutions that exist for folks in all types of situations, and can provide well informed guidance toward the products which best suit your unique needs.

  • We shop around

When you are looking to buy something that costs more than $1,000, do you go to one store, hear their pitch and then buy whatever product they offer you? Wouldn’t it be smart to consider looking at other stores? A mortgage broker is like a personal shopping assistant who can bring you the best from over 45 mortgage lenders. This is the best way to get to know what products are offered across the industry. You could call all the lenders in Canada or the GTA, it wouldn’t be THAT hard, but you could also let a broker point you in the right direction.

  • We negotiate on your behalf

Not surprisingly, many clients I have dealt with have issues negotiating with the bank or asking for a better rate. As brokers we demand a better rate. The banks and lenders know us, and know we are fully informed negotiators who know what price it will take to get our clients’ business. This negotiating power and experience combined with our volume as partners of the lenders make us the most suitable champion of your interests.

  • We provide service for life

Many lenders will let your mortgage roll over every term and automatically renew you until you re-actively check into your options. Good brokers have a duty to follow up with you every few months to ensure your product is still working for you, and to investigate whether you might benefits from a change in your mortgage. We follow you every step of the way until you are mortgage-free.

Essentially, a mortgage broker is an expert shopper who is paid by the lender to provide you with a mortgage. You have absolutely nothing to lose, and everything to gain by dealing with a mortgage broker. Now that we have cleared that up, happy home buying!

Full disclosure: I am a net-present-value ninja and mortgage agent at Northwood Mortgage. Call me anytime at 416-371-2077.

The Not So Savings Account

When I was 16 I had $5,000 in my bank account which I’d earned working full time in the summers at a property management company reporting repairs that tenants required. At the time interest rates were about 2% on a savings account. Frankly speaking, a savings account is just a storage space for your money, when you need it fairly quickly. Had I understood a little bit more about finance, I may have sat down and thought of where my money could work harder for me.

When you should lock your savings into an investment

Like most 16 year old, I didn’t have many expenses. I was living at home and spending my money primarily on entertainment, and eating out. Now that I think of it not much has changed, but that’s beside side the point. I had $5,000 of liquid funds that I likely would not need in the near term, having money coming in from a job each summer. It was at that time that I should have evaluated how much of my saving account I might need over a reasonable time horizon. I could have easily put away $3,000 toward an investment for a few years.

When will you buy your next big ticket item? A car, a down payment on a home, and a capital investment for your business are just some examples of times when you might need cash quickly. The first step in your personal investing strategy is deciding when you will need your money and how much of it you can set aside for different purposes. You may quickly find that you have too much money in one source or another, and can earn more investment income by allocating your wealth more strategically.

Types of investments and their time horizons

Type of Investment Annual Expected Return % (Mar 2014) Time Horizon What my $3000 is worth after 3 years
Bank Savings Account 0.1% to 0.5% Liquid assets $3,022.55
Treasury Bills Around 1% 3-6-12 months $3,090.90
Short Term GIC 0.5% to 0.8% 30 days to 1 year $3,072.58
Long Term GIC 0.9% to 2% 1 to 7 years $3,100.09
Mutual Fund 10 Year Average 5.85% (BMO NA Equity) Liquid assets $3,557.90
Lend for Mortgage Transaction 5% – 10% 1 – 5 years typically $3,573.05
Stock Market Index Fund 14.6% (Last 12 months) Liquid assets $4,515.18

There are many types of investments which can earn you all different types of returns and force you to bear different levels of risk. Be careful to take your time in deciding what is best for you, but as you can see, you can do a lot better than a savings account at the bank!