Many wish that money grew on trees or that they can make money while they sleep.  I will leave the first wish up to scientists and the government, but the second is easily attainable.  This can be done by understanding the Time Value of Money. What is the time value of money? How does it affect me?  You may have asked yourself these questions before, and hopefully I can shed some light on this very important principle.

The absolute first element of understanding the time value of money is understanding compound interest. Albert Einstein considered compound interest as the eighth wonder of the world.  Compound interest simply means continuing to receive interest on interest.  Over time this simple principle can be very profitable.  Most everyone has experienced compound interest.  If you have ever had money in the bank, then you have.  In a sense, people are willing to pay you interest, in return to borrowing your money for a period of time.  As time goes on, that interest payment goes up more and more.  Interest can be compounded on a variety of different time frames.  Annually, monthly, quarterly, or even sometimes daily.  Knowing how compound interest works, will help you to appreciate it and utilize it in your planning.  See below a basic example of a short term view of what compound interest can do in a short period of time.

Another important thing to know when dealing with the time value of money, is that a dollar today is worth more than a dollar tomorrow.  Due to continual increasing cost of goods and the saturation of printed money (inflation), the worth a dollar will go down as time goes on.  The value of money today is known as Present Value. The value of an investment in the future is called Future Value. With the help of some equations or a good financial calculator, you can roughly calculate what a sum of money today will be worth in 10 years.  This is a vital step in understanding investment and what vehicles to use to increase your reserves.

You can really see the magic of compound interest work in your retirement accounts.  Since these accounts usually are not touched for several years, you can take advantage of compound interest and watch your money grow into a very healthy retirement, because you made the right investment.  By understanding the time value of money, you will be able to better evaluate potential investments and plan for the true value of your money in the future.  Remember,  a million dollars today will be worth significantly less than a million dollars in 2060.  So take some money from under the mattress and start by finding a good savings account with a healthy compounded interest rate to start making money in your sleep.