Why a pound today beats a pound tomorrow
There are three reasons a pound today is worth more than a pound in the future. First, you can invest it and earn returns. Second, inflation means future money buys fewer goods. Third, there's always some risk that the future payment won't arrive at all. These three forces — investment opportunity, inflation, and risk — all push in the same direction: making future money worth less.
Present value and future value
The time value of money gives us two key formulas. Future Value (FV) tells you what money invested today will grow to: FV = PV × (1 + r)^n, where PV is present value, r is the interest rate, and n is years. Present Value (PV) does the reverse — it tells you what a future sum is worth today: PV = FV ÷ (1 + r)^n. This "discounting" is how analysts value bonds, loans, and entire companies.
| £1,000 invested at 7% annual return | Value after N years |
|---|---|
| 5 years | £1,403 |
| 10 years | £1,967 |
| 20 years | £3,870 |
| 30 years | £7,612 |
Discount rate: the engine of valuation
In financial analysis, the rate used to convert future cash flows back to present value is called the discount rate. A higher discount rate makes future cash flows worth less today (reflecting greater risk or higher opportunity cost). This is why rising interest rates tend to hurt growth stocks more than value stocks: growth companies' profits are mostly far in the future, and a higher discount rate shrinks those future profits dramatically in present value terms.
"Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it." — Often attributed to Einstein (likely apocryphal, but the maths is real)
What this means for you
The time value of money has one practical message: start investing as early as possible. The difference between starting at 25 and 35 — assuming the same monthly contribution and the same returns — is roughly twice the end wealth, because of an extra decade of compounding. Every year you delay investing is not a neutral choice; it's a choice to make future you poorer.