If there is one concept of finance and investing which is at the same time the most important and the least understood, it would have to be the time value of money. It’s the fundamental building block that the entire field of finance is built upon. And yet, many people lack a solid understanding of how it works.

Time value of money is the economic principal that a dollar received today has greater value than a dollar received in the future. If you were given the choice between receiving $100 today or $100 in 10 years, which option would you take? Clearly the first option is more valuable because of:

Risk – There is no risk of getting money back that you have today.

Purchasing Power – Because of inflation, $100 can buy more Mars bars today than it will in 10 years; and

Opportunity Cost – a dollar received today can be invested now and earn interest. However, a dollar received in the future cannot begin earning interest until it is received. This lost opportunity to earn interest is the opportunity cost.

All time value of money problems are solved using two fundamental calculations: compounding and discounting.

Compounding is the process of determining the future value of an investment made today and/or a series of regular payments.

Most people understand the concept of compound growth. If you invest $100 today and earn 10% interest for two years, your initial investment will grow to $121 at the end of year 2. The initial $100 compounds because it earns interest on the principal invested, plus it also earns interest on the interest.

Discounting is the process of working out the value in today’s dollars of money to be received in the future, as a lump sum and/or as regular payments, by applying a discount rate. The discount rate is the required rate of return or opportunity cost of an alternative investment.

It is impossible to make a sound investment decision without using these calculations, yet few do so accurately.

To illustrate with a simplified example, if a property you want to buy is worth $500,000 today and you require a 10% return, assuming you hold it for 10 years and receive a yield of 2% after all expenses, you would need to sell it for around $1.1m in 2025. To help work out if that is realistic, you could discount back from today’s value to 2005 at the same rate of return and compare it to sales prices at that time.

There are obviously a lot of other variables to consider, so, as always, see a professional before you invest. It could save you thousands.

If you would like to learn more about prudent investing, please send me an email or drop in for a chat.

If you would like  to contact Campbell Korff of  Yellow Brick Road Ballina go to: www.ybr.com.au/Branches/Ballina

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 Small business underpins our economy and provides a source of income and store of wealth for millions of Australians, writes Campbell Korff. This means that those same Australians also rely on the value realised from the sale of their business to support them in retirement – and that can be a problem.

I have discussed previously how not enough small business owners are making use of the huge tax advantages of superannuation during their working lives. All is not lost, however, if you are in this category. The government anticipated this and has provided small business owners with special tax concessions when they sell their business assets at retirement, provided they then make use of superannuation.

What this all means is that it is critical that business owners maximise the value of their businesses when they sell out or retire.

For most, however, this means seeking offers a few months before they need to sell from their own network or possibly getting a local real estate agent to do some advertising. Having negotiated a quick deal with a competitor or staff member, a short meeting with their accountant and solicitor follows to work out the tax bill and contract.

Where was the planning? Looking before your leap is probably a good idea…

Given most small business owners put their heart and soul into their businesses for most of their lives, this process hardly seems to be doing justice to a life’s work.

Where was the planning? What was the valuation method? What steps did the owner take in the years leading up to exit to maximise that value? Was a sale the best exit or would more value be captured by structuring a succession plan for a promising junior? Were other structures available to entice the buyer to pay more? Was a tax and retirement plan developed beforehand?

Exiting a business successfully is a complex process during which hundreds of thousands of dollars of your wealth can be destroyed if care and, importantly, expert advice is not taken well ahead of time. Indeed, to a certain extent, you should always be buyer ready because you never know when that ‘too good to refuse’ offer might land on your desk.

If you want to contact Campbell Korff of  Yellow Brick Road Ballina go to: www.ybr.com.au/Branches/Ballina

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