What is meant by the 'time value of money'?

The concept of the 'time value of money' is fundamental in finance, encapsulating the idea that a specific sum of money today has the potential to earn interest or generate returns over time, thereby increasing its value. This principle is based on the premise that money can earn returns, and thus, a dollar received today can be invested to grow in the future. The greater potential earning capacity of money today, as opposed to the same amount in the future, highlights why the present value of money is significantly higher than its future value.

By recognizing that having money available now allows for investment and compounding over time, it becomes clear why this choice accurately captures the essence of the time value of money. Investors are encouraged to consider not just the nominal amount, but also the opportunity costs associated with time when evaluating their financial decisions. Understanding this principle is crucial for making informed investment decisions and effective financial planning.