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Cash now vs. cash later
You' d rather get $1,000 today or $1,000 a year? It seems the answers are quite clear - almost everyone would take 1,000 dollars today. Would you rather get $1,000 today or $1,100 a year? When you ask a group of persons, you would probably get a miscellaneous reply.
Wellcome to the temporal value of money. Fair value is the notion that a U.S. Dollar today does not necessarily have the same value as a U.S. Dollar tomorrow or in a given period of a given year. For the most part, a greenback obtained today is actually more valuable than a greenback obtained in the later years.
Most importantly, the money we receive today can be spent earlier to generate revenue than the money we receive in the money we receive in the money we receive in the future. When you make a one-time $1,000 in investment in the market today and the markets return 7% per year, then you have a year from now $1,070.
So, back to the initial example - would you rather have $1,000 today or $1,100 a year? Depending on what returns you can generate with your investment. $1,000 today versus $1,100 a year means a 10% rate of return. Mmm. But if you can get a higher rate of returns in another way, it's better to get the $1,000 today.
However, if 10% is the best rate of Return you can get at your chosen levels of exposure, then you better hold on and get $1,100 a year from now on. Would you still be paying $1,000 today to get $1,100 a year from now on? Same principle holds true - this is a 10% yield and it will depend on what yield you could get elsewhere.
The principle is valid regardless of whether you save for your pension, speculate on the exchange or invest in new devices for your company. Your response will depend on what yield you could get elsewhere. The determination of the required yield is decisive for the choice between different types of investment, whether private or commercial.
We will be happy to help you calculate your anticipated rate of returns.