We’re often warned about the dangers of instant gratification. In the infamous Stanford Marshmallow Experiment, schoolchildren were presented with a marshmallow on a plate. They were given two options: eat the marshmallow now and get not get any more, or wait for a certain amount of time and then receive two marshmallows as a reward for their patience.
The conclusion that the marshmallow experiment seems to come to is that delayed gratification will always yield the most rewards. However, life isn’t as simple as a controlled experiment. If we’re talking about money, there are times when instant gratification provides a better, more viable option. After all, unlike marshmallows, you can do more with your money than just eat it away. For example, if you were offered $1,000 today versus $1,000 next year, you would choose to take it today. That’s not just because of instant gratification. It’s because, in this situation, waiting could actually cost you — that $1,000 could lose value due to inflation.
The time value of money
In our example above, that one-year wait could have afforded you many opportunities for investment, and thus, many opportunities for returns. In this situation, we see the concept of the time value of money (TVM) in action. According to a TVM overview on AskMoney, the concept behind time value of money argues that a certain sum of money will be worth more when received in the present rather than in the future. This is because inflation can cause the sum to decrease in value. Additionally, delaying access to the money prevents you from gaining any returns, should you choose to invest it.
Applying TVM
The time value of money isn’t just about having instant access to money. It’s also about having more time to make your money work. For example, let’s say you want to save for retirement. Would it be better to start investing in your 20s, when your income is smaller and retirement is a long way away? Or would it be better to invest in your 30s, when you can afford to make substantial investments? TVM argues that it will always be the former.
Experts at Business Insider argue that investing in your 20s will earn you more money by 65 than investing in your 30s. Let’s say that each individual makes monthly investments worth $100 with a 5% annual rate of return. The person who invested earlier will have $73,000 more in savings than his counterpart, even though he only contributed $12,000 more.
But why is that? The person who invested earlier on understood the concept of TVM and gave their money more time to compound. With compounding, money doesn’t grow linearly: you make gains from interest, and then your gains make gains, creating a snowball effect. Your money’s growth potential increases the longer it’s invested, simply because the interest applies to your investments as a whole — including the revenue generated by the interests — and not just the money you wire into your investments.
The bottom line
The main idea of TVM is this: when an opportunity arrives, don’t wait. You’ll be wasting your growth potential if you do. As long as you know the risks, and know how to grow your money, earlier investments will always make the best returns. As The Guy Who Knows a Guy, I know a little about a lot, including making the most of your investments. If you would like to work through your options and get referrals to reputable experts who can help you with investment or anything else you need, book a call with me.