The Value of Your Money
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Wednesday, 10 October 07 - 01:00 AM (GMT +08:00) By Sing Chie Tie in Money Matters |
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You win a lottery. You win big – RM 100,000! Instinctively you will go and redeem the lottery ticket right away despite the ticket fine prints say that you have 3 years to redeem your loot (hey, how many people's RM1.00 contributed to your RM 100,000?) before it turned worthless.
What are you going to do with your RM 100,000 is a story of another day. The point I wish to put across to you now is, "How valuable is your RM 100,000?"
So How Valuable Is It?
If you redeem the loot now, the value of your loot is RM 100,000. If you totally forgot about the ticket and redeem it three years from now, you will still receive RM 100,000 in physical cash but its actual value would be RM 94,232.23. Because of your forgetfulness, your RM 100,000 just lost its value up to RM 5767.77 in three years. Quite a sucker, heh?
Huh?
The value of money shrinks over the years and one of the causes of it is due to inflation. Your RM 100,000’s true value is eaten by inflation. If the inflation rate for the three years is at a steady rate of 2%, you have lost RM 5767.77 unknowingly.
You can work this out by using the below formula:
Where
PV = Present Value
FV = Future Value
i = inflation rate
n = number of years
In English, the above formula means, “What is the present value (PV) of the future value (FV) at the inflation rate of i for the next n years.” If we translate it to our little example, it will sound something like this: “What will be the actual value of RM 100,000 if I am to redeem the lottery ticket 3 years from now assuming the annual inflation rate is at a constant 2%.”
Why Are You Doing This?
You can only spend your present money. In order words, you can’t spend what you don’t have. Money in the future is something you don’t have until you are at that point in time (i.e. You can’t spend the money you are going to get 3 years from now today simply because you do not have that money physically in cash form today). And because you can’t have the future money now and your eternal silent nemesis – the inflation – is always being one of the most persistent universal creation of mother nature will take its own sweet time eating away the value of your money making your money less valuable over the years.
So What Can I Do Now?
Cash is kingly but cash at hand is the real king. Own what you suppose to own now and find every darn way to beat the annual inflation rate. The safest way is to put in the fixed deposit that currently yields 3.7% per annum. That way, as long as inflation rate is lower than the fixed deposit rate, you have successfully beat the inflation and preserve, if not grow, the value of your money.
Does that mean if I redeem my lottery ticket today I will have RM 111,515.77 in cash value 3 years from now if I deposit all my loot into a fixed deposit that pays 3.7% interest per annum without any withdrawal?
Well...yes and no. Yes that you will receive a physical cash of RM 111,515.77. No because the actual value of your physical cash is only RM 105,187.19 because the inflation rate is at 2% per annum. Therefore 3.7% - 2% = 1.7% gives you an effective interest rate of only 1.7%.
Geez, that’s such a sucker!
You bet! That’s why it is absolutely crucial for you to know the value of money. The value of money is at is present time. The future value of money is dependent of how you beat the inflation rate.
Hey, winning RM 100,000 ain't that big a sum!
Have you actually win RM 10,000 before? If not, be contented with it. Buddy, its just an example!
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