Dear Young Investors

The Time Value of Money is a widely understood attribute of money. Essentially, all it means is that money today is of more value than money in the future. There are two basic drivers of this; inflation & opportunity cost.

Inflation is something that most people are well aware of. The price of goods and services tends to increase over time, hence a R100 note today can buy you more today than that same note in 5 years’ time. The Big Mac index is a broadly used graph to illustrate this inflationary effect in motion.

Opportunity cost is the implicit loss experienced when an alternative option would have added more value than the option selected. Coming back to our R100 note; the opportunity cost of tucking it under one’s mattress versus keeping it in the bank, is the interest that the bank offers.

Luckily for South Africans, over most time periods the money market has equaled or beaten the Consumer Price Index (CPI), which serves as our substitute for inflation in this discussion. This tells us that by simply having money in the bank, one could expect to not have to worry about the effect of inflation eroding the purchasing power of that money, only eroding the opportunity cost (interest from the bank). However, funds invested in equities over the long term historically outperform the money market and thus inflation.

A valuable application of the time value of money is the understanding that retirement funds invested by young people are actually worth more than those closer to retirement.

The graph below illustrates what R100 contributed to one’s retirement fund today could be worth to that investor on retirement (inflation has already been taken into account).

Note: an assumed growth rate of 10% and inflation of 5% has been applied.

People who contribute more in the earlier years of their investment have a significantly smaller savings gap to close when they are older. Keep in mind that you as an investor exist on this graph, and every year you move closer to retirement, and hence slightly to the left, where your contributions could have less value at retirement.

We’d encourage those younger investors that have the means, to increase their retirement contributions now so that they don’t need to play catch-up down the road.