Time Value of Money

Like most of the things money also loses its value if kept idle. Its mainly because of inflation, which increases the cost of goods and the purchasing power of money decreases.

Its better to invest money in something which can give an interest which is more than inflation. Generally the safest place to keep your money is the banks. They give an interest on your deposit. Most of the time the interest is compounded. Compounding makes a big difference in the long run. Compounding essentially means that you will get interest on 'interest earned' besides the usual interest on the initial amount (principal). It keeps on accumulating period after period. Generally the interest rates are compounded annually - meaning the interest you will earn after the end of a year will start fetching you more interest from year end onwards.

Power of Compounding
Compounding creates a big difference in long run. The table shows the the Future Value of Rs 100 after several years.
One may ask that who has seen 200 years and from the table it appears that it doesn't make that big a difference during a short span, say of 10 years. But what happens if you get 20% interest rate.
Now certainly the difference cannot be neglected.
The formula used for calculating Future Value (FV) is pretty simple.

where FV is Future Value, PV is Present Value, r is rate of interest compounded periodically (generally compounded annually), n is the number of periods (eg. number of years if interest rate is compounded annually)
Next article we will discuss about Annuities.