One of the fundamental principles of finance is the concept that N1 today is more valuable than N1 a year from now. The reason for this is two-fold. First, a naira will probably buy less goods and services in the future due to the destructive force of inflation. Second, if I have the naira in my hand today, I can invest it and earn a return in the form of dividends, interest or capital gains.
The time value of money is a basic financial concept based on the assumption that a naira received today is worth more than a naira received at some future date because a naira received today can be invested and earn interest.
There’s more to the concept of the time value of money, but the most important thing for you to remember is that receiving N1 today is better than receiving N1 tomorrow, and the entire amount in a lump sum is better than instalment payments (assuming there’s no interest involved). If you’re paid in instalments, you lose the opportunity to invest the lump sum for a longer period of time.
The best money advice anyone can ever give you is to firmly establish this time value of money concept in your head. The key to financial prosperity is realising the potential value of every naira that comes into your hands. In fact, think of cash as a seed – you can either eat it (spend it) or invest it (sow it).
To help illustrate this point, let’s assume you find a N200 note on the side of the road. You are faced with two potential uses: you can save the money or spend it, may be buying some midday snacks. “It’s only N200!” you say to yourself and opt for the snacks. In reality, you are spending far more. Using one of the time value of money formulas (FV = pmt (1+i)n: FV = Future Value, Pmt = Payment, i = interest rate, N = Number of years), we can calculate the future value of the N200 in 5 years time with an interest rate of 10%.
The future value of the N200 will be about N1400 in five years time. That means your real purchasing power would have increased approximately 7-fold.
Clearly, this is enough to buy an entrée at a five-star restaurant! Armed with this knowledge, you are free to make an economic decision; namely, would you prefer to eat a N20 meal today or a N1400 meal in the future. The answer is entirely personal. Once you understand this concept, however, it becomes painfully obvious that the small luxury items you think nothing of are really costing you millions and millions of naira in future wealth.