A penny saved is a penny earned – or so the adage goes. In fact, a penny saved may be more or less than a penny earned, depending on when it’s earned and how it’s saved. The reason is rooted in a concept called the time value of money and its close cousin, opportunity cost. Would you rather have $10,000 today or $10,000 a year from today? Of course, you’d take the money now. Not only is a bird in the hand worth two in the bush, but $10,000 will be worth less a year from now due to inflation. Delay costs a year’s worth of earnings. Failing to understand how the time value of money works can cause us to think we’re doing something smart when we may not be. For instance, we’ve heard praises sung for the 15-year mortgage. Because we pay it off sooner than a 30-year loan, we pay less interest and save thousands of dollars. But the homeowner with the 15-year mortgage parts with the money sooner. Here’s where opportunity cost – the cost of doing one thing and not another – comes into play.
Chris Bryant is an American financial advisor.