A dollar is a dollar at any time right?
It might seem like a silly question. A one dollar coin is not going to change value overnight, tomorrow you will still be able to use it to buy the same apple or banana at the shop.
Let’s not think about it in terms of one dollar coins. Instead, we will consider a concept…
By the nature of money and the way the financial system works, the fact is that a dollar you have today is more valuable than a dollar you will get tomorrow. This is a very important concept to get your head around if you are interested in saving or investing.
Known as the Time Value of Money (TVM), it literally means that today’s dollar is worth more than tomorrow’s dollar.
Other than the immediate gratification of having something good in your hands today, let’s explore why a dollar today beats a dollar tomorrow, and why you need to do something with your dollars now!
Why Does Inflation Mean a Dollar is Worth Less Tomorrow?
Remember when you were a kid and you could buy a box of Jaffa’s with a few coins of your pocket money? Try doing that now and you will understand inflation. Heard the term inflation but aren’t sure what it means? To put it simply, inflation is the rising cost of goods and services.
Say you keep $10 in a piggy bank for a year and inflation goes up by two percent. You pull out the $10 note and yes, you still have $10, but because everything else became more expensive, you won’t be able to buy the same things with it that you could have one year ago. In a nutshell, the purchasing power of your money decreased.
So, the dollar you have in your hand today holds more value than the dollar you get tomorrow. Even if the difference is only tiny, over months, years and decades, those changes are compounded.
How to Stop Your Dollar from Devaluing
Okay, clearly it’s not a great idea to keep your cash in a piggy bank or stuffed under your mattress, so how can you help your money keep up with the inflation rates?
The simplest way – and the way all kiwis are familiar with – is to stash it in the bank and leave it there for as long as possible. Money in the bank gathers interest, with most NZ accounts fetching interest rates of around two percent. Money stored this way should at least increase in value at the same rate as inflation.
How to Increase the Value of Your Dollar
But you don’t simply want to keep up with inflation. You want to increase the value of your dollars right?
This is where the power of investing comes into play. The goal is not to simply to keep your money stable, but also to grow it. Although there is always a small amount of risk to investment, if you diversify (spread your money between different shares or companies) and stick it out for the long haul, you should be able to beat inflation.
How much you beat it by depends on a huge variety of factors – generally the higher the risk, the bigger the reward.
Putting your money into a savings account or investing it enables the magic of compounding interest to kick in. Over time compound interest will allow you to outpace inflation.
Here’s how it works:
Say you have $100 in your savings account and earn three percent interest. In one year, you will have $103, which will earn another three percent on the new total resulting in $106.09.
This compounds year after year – effectively you earn interest on your interest as well as the original sum you invested in the first place. Over long periods, these figures can become pretty impressive.
One last note on using today’s dollar instead of waiting for tomorrow’s. That note is the fear of missing out (or FOMO, as the cool kids say).
Let’s put it this way, you see an awesome pair of shoes on sale but wait for next week to buy them. You show up at the store to find the sale has finished and your opportunity has been lost.
Don’t risk those “opportunity costs” by delaying on your investing.
The key takeaway here is to get your money working for you today, don’t sit on it waiting until you have “enough.”
Investing even the few dollars you have today will make a difference tomorrow.