Building wealth is a lifelong pursuit. Creating a nest egg is essential for retirement, yet many of us are failing to do what it takes to retire comfortably and on time. Maybe that’s because so few of us really understand the important financial concepts that govern our personal financial strategies — or that should govern them, anyway.
Those key concepts include the ones discussed below: cash, assets, and the time value of money. What is the time value of money, and how does it relate to cash and assets? When is it better to have an asset, and when is it better to have cash? Here’s what you need to know.
What is the time value of money?
The time value of money is an important concept in economics and finance. Fortunately, it’s also a very simple one: the “time value of money” means that a certain amount of cash is worth more now than the same amount would be worth later. In other words, if you’re offered the choice between $10,000 now and $10,000 a decade from now, you should take the money now.
Why? Because money isn’t just for holding and hoarding. It’s for using, and what you can use it for can increase your overall wealth. You could take that $10,000 now and start a business; a decade from now, that business may well have made you more than the $10,000.
Then there’s inflation, which actually reduces the worth of cash over time. You can’t escape that just by taking the money early, but you can use investments and other things to match or even exceed inflation if you have the cash to do so now.
Using the time value of money to save
The time value of money is an important thing to remember as you save for retirement. When you’re putting money away for retirement, you are often investing it. That means you have an investment instead of cash, but you’re getting something in return for the cash: a chance at growth. In a way, you’re not giving up the time value of your cash so much as you are making use of it.
And the longer your money works for you, the more you’ll make. Thanks to compound interest, money saved early in your career can be worth much more than money saved late. “Compound interest” refers to the fact that the interest you earn is added to the principal, making the principal larger and generating still larger amounts of interest in a virtuous cycle. Each dollar saved in your 20s is worth 10 dollars saved in your 50s. Talk about the time value of money!
Converting assets into cash
But what about assets? Assets are valuable things you own, and they can make a great deal of financial sense. Take owning your own home, for instance: that can increase your wealth and save you wasted rent money. But assets cost cash, and you just saw how valuable cash can be.
As you grow older, you’re likely to find that a great deal of your wealth is tied up in assets like your home, valuables, and even your insurance policies. And there may come a time when you need cash fast. Imagine, for instance, that you have steep medical bills to worry about. Your life insurance will surely pay out after you pass, making your policy a potentially valuable asset — but how does that help you now?
What you can do in this case is convert your assets into cash. A viatical settlement will allow you to swap your future payments for cash now. You’ll get less cash than the eventual payment is worth (remember the time value of money), but the transaction can be well worth it if it allows you to pay down bills and avoid the cycle of debt.
Whether you’re saving for retirement or trying to drum up cash in your golden years, you don’t have to do this alone. Turn to experts for help! A financial adviser is just the professional to turn to when you have serious questions about your financial future.
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