True Time Value of Money

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The economic depression that began in 2008 has decimated many people’s bank accounts, retirement accounts, and other investments. After losing considerable sums in the stock market, and being faced with the possibility of a run on the banks, many people have opted to keep their money in ultra-safe instruments paying almost no interest at all. They believe, erroneously, that their money will thus be safeguarded. Putting your money under the mattress pays nothing at all, but at least it’s safe, right?

value of money

A Low Interest Rate Environment

Let’s examine this a bit more deeply. Is your money truly safe in ultra-conservative instruments, such as U.S. Treasury bonds? True, they are backed by the full faith and credit of the United States, but under current circumstances, the United States hardly enjoys much “credit” in the eyes of the world. In fact, we have become a nation of debt. This debt has been created over the past few years by the Treasury pumping huge sums of money into the economy in an effort to stimulate it.

But in order to stimulate the economy, the Treasury has reduced interest rates down to almost 0. This is a double-edged sword. On one hand, with interest rates this low the cost of money, such as how much interest is being charged for a loan, is very low, presumably permitting people and businesses to borrow more and thus spend more. On the other hand, people’s savings accounts earn almost nothing.

Are Treasury Bonds the Answer?

In order to get slightly better return on money, some people opt for Treasury bonds. As we have seen, they pay a very meager amount of interest, which is not that much better than mattress stuffing. In fact, you are losing money. The annual inflation rate was recorded at 1.5 percent for the past quarter. If inflation rises at 1.5 percent, but you are only earning 0.71 percent with your money tied up for the next five years, you are in effect losing 0.79 percent per year (1.5 percent – 0.71 percent). That may not sound like much at first, but compounded over time this becomes quite significant. This is not even taking into consideration that inflation might rise in those five years.

Opportunity Costs

There is something else to consider. While interest rates are so low, so are prices. For example, housing has been the market sector that has suffered most, with many areas of the country losing 50 percent or more on house values. As the economy improves, so do house prices. Some properties have shown tremendous values if purchased during the past few years with a view to reselling them when the economy improves.

Imagine, for example, that two years ago you decided to invest in a small fixer-upper. You bought the house for $50,000, painted it, put a few flowers in the yard, and rented it to Uncle Charlie. Today, that same house is worth around $60,000. If you bought that house for cash, your return on investment (ROI) would be 20 percent. It’s actually much more if you count Uncle Charlie’s rent. Instead, if you chose to invest your $50,000 to buy a two-year Treasury paying 0.71 percent, your ROI would be $710.00 for those two years ($50,000 x 0.71 x 2). Your opportunity cost would be $9,290 over those two years – painful.

There is a misconception that keeping your money safe means taking no risks at all, parking your money in so-called ultra-safe instruments such as money markets, and feeling secure that nothing will be lost. In fact, you are losing money because of inflation, and most considerably because you are not taking advantage of opportunities which may be quite reasonable if examined with a clear and rational head.

This article was written by Richard Craft, a current MBA student, on behalf of KEL Credit Repair, your number one choice when looking for credit repair services. Check out their website today for more information on how they can help you and your credit!