Time
Value Of Money...Continued
(If
you want to know what I would do after winning a lottery,
you can ask me on the beach.
That is where I will be.) For some, the security
of monthly payments and the fact that they are
not surrendering 1/2 of the face value of their
annuity is more comfortable.
Others would rather see the $500 thousand cash now,
and not wait to receive payments over a 25year
period. In other words, payments over time are worth more
than a smaller amount of cash now. To others
it is the opposite.
They would rather have a chunk of cash in their
hot little pockets now, rather than receiving periodic
payments over 25 years. It is that simple.
To
put it another way, as a general rule, the longer you have
to wait in the future for your money, the less it is worth
today.
Before
you can even consider buying, selling or dealing
in notes, or any investment for that matter, the concept
of the time value of money (TVM) must be understood.
Once you have mastered this concept, you will understand
with ease, all forms of notes, and will be able to
make intelligent decisions on TVM, no matter
what financial instrument is thrown at you, whether it is
a house payment, zero coupon bonds, credit cards, or discounting
a lease or an annuity. You will be able understand better,
car payments, as well as immediately recognized how the “specials”
that credit card and other finance companies give us, are
not specials at all, but credit traps.
To
analyze the TVM, there are five variables that
interrelate with one another.
The five variables are the number of payments,
yield, amount of payments, present value,
and future value. When one of these variables changes,
another variable also changes. There you go, Professor, with
all that mathematics stuff again. This is going to be hard,
isn’t it? Nope,
not at all. Thanks to the wonders of modern inventions,
we can now transform the concept of TVM into
solutions without having to do a bit of math. We just need
to know where to put the numbers and which buttons
to push on a calculator. Here are the variables and the buttons
on a calculator.
PV:
Present Value: The
value of a dollar today due in the future or in a series of
payments, to give an investor a certain yield over a period
of time.
FV:
Future Value:
The value of a dollar at some time in the future
from a lump sum payment, or series of payments. Simple example
would be a balloon payment due in 5 years, or how much would
you have if you saved one dollar a month for five years at
6% compound interest.
%i:
Yield: This
term is often interchanged with rate of return or interest.
N:
Number of pay periods: The total number of periodic
payments on a note. Usually in terms of months. It can be
years, quarterly, semiannually, or even weekly.
PMT:
Amount of payments:
The amount of dollars received or paid out in periodic
payments to achieve a certain rate of return, and to amortize
a loan.
Can
you find these keys on your business calculator?
You don’t have one?
If you are serious about dealing in real estate or
notes, a business calculator is a must. Get one; you are going to need it. (For under $40 you can get
a business calculator that is both user friendly and efficient.)
The
example that is frequently given to explain the TVM is
the story of the settlers buying Manhattan for only $24.
We look at that today and say, what a steal.
Few have ever considered it might have been all that
the land was worth in dollars 300 years ago.
If the $24 had been place in an interest bearing account
drawing 7% that $24 would be worth several trillion dollars
today. (I wish I could give you an exact figure, but I
do not know the exact date this real estate transaction took
place, but I think you get the point)
Keep
the five TVM variables in mind.
Remember them and learn what they mean and represent.
These five variables are the basis of understanding
and calculating the TVM and discounting notes.
Understanding how these variables relate
to one another is a cornerstone for making you a wealthy.
On
the EDUCATION Page, you will learn how to apply
these principles in everyday life to not only increase
your yield on investments, but to turn a seemingly bad
deal into a profitable one.
In
the next issue of NOTE PROFESSOR, we will continue
this series on The Time Value of Money. The Professor will
discuss the different variables, what they mean, and how they
relate to one another.
TO
BE CONTINUED Next Month
If
you have questions or comments, contact the NOTE PROFESSOR.
