The “Time Value of Money” is a foundational principle in finance and economics. It states that money available today is worth more than the same amount in the future due to its potential earning capacity. But why? What does this mean? Why does money have time value? In the prior essay, “What is Money?”, I argued that money is just a medium of exchange for time. In that case, “Time Value of Money” is a bit of a word salad. The more proper phase is simply “Time Value” or “Earning Capacity of Time”. In this essay, we will explore this idea.
But let’s start with a thought experiment:
For 100 days, you are stuck on a deserted island with only a knife. Every day, you have three options:
- Leisure.
- Build fishing equipment (spike, rod, nets, etc.)
- Catch fish.
With just the knife, you can catch one fish per day. You can endure long periods without food, but by the end of the 100 days, you must have consumed at least 100 fish (could be all on the last day). What strategy would allow you to have the most leisure time?
Evidently, if you choose to fish with just the knife, you’ll meet your food requirement but have no leisure time. The best strategy will depend on how much our efficiency (productivity) of catching fish improves each day spent building equipment. In other words, we want to minimize the combined days spent building equipment and catching 100 fish, maximizing our leisure time. The critical insight here is that it’s better to build equipment initially and not fish until we have reached the proper efficiency to achieve our goal with minimum effort. This is the essence of ‘The Earning Capacity of Time ‘. Time has value because it can be used to enhance productivity and efficiency. By investing time upfront, you can increase your future output per unit of time. This thought experiment illustrates the trade-off between productivity improvements and direct labor or leisure. Time now can generate more future time, if used wisely.
Let’s look at another example. We have found a new fully automated factory method that builds cars more efficiently. However, we must forgo some of our time and borrow the time of some engineers and construction workers to make the new factory. There is a cost to borrowing someone else’s time; let’s call that the cost of time (aka interest rate). If the new factory can produce automobiles more efficiently, we could make more cars than before per unit of time. This, in turn, means that we can earn more, repay the lender of time, and have time/money left over for us. This is why having time now (capital/money) that can be used to boost productivity is more valuable than having time in the future and why borrowing someone else’s time has a cost.
The “Time Value of Money” principle is based on a simple idea that can be applied to various aspects of life, not just economics and finance. For instance, investing time in functional education or skill-building can lead to higher earning potential, freeing up more time for leisure or other pursuits. Similarly, investing in tools, technology, or infrastructure can increase efficiency, reducing the time spent on tasks and allowing more time to focus on high-leverage activities. However, we can also destroy time. For example, getting an education in a major with no practical value, building an inefficient factory, etc. By prioritizing current time investments wisely, we can create a positive feedback loop where time begets more time. Or, as people inappropriately say, “Money begets Money”.