What Is Time Value of Money?

Understanding Time Value of Money

First Published: ADawnJournal.com June 23, 2010

Everyone wants to know how much their money is going to be worth down the road. Not only that, knowing how much money you may have will help you save better and make more money. Over the course of this article, I will cover four important concepts. They are:

1.   Time Value

2.   Present Value

3.   Net Present Value

4.   Future Value

All of these concepts will center on the value of money. We all know that money is valuable, but what about the time value of it? What is it worth now, how much is it truly worth now, what is its future value? All of these need to be understood if you are going to get the most out of your money.

Time Value

The time value of money is the value that is given to the amount of interest earned by the money over a certain period of time. That means that if the money earns a few dollars interest, then its time value will be based on how much value will be associated with the money and the interest. Here is a simple example to help show what we mean:

Let’s say you have 100 dollars right now and you put it away in an investment that earns you 10 percent over the next year. That means that your original 100 dollars is going to be worth 110 dollars in about a year. So, 100 dollars paid out now, or the 110 dollars paid out in one year will have the same value to the recipient who assumes the interest. However, using the time value of money, we know that the future value of the money is going to be 110 dollars. What makes this important is it allows a person to determine their future annual incomes. That way, annual incomes are discounted and added together to create a lump-sum that is the present value of a total income stream.

Present Value

The present value of money is the value of money on a given date for a future payment, discounted to reflect the time value of money and other factors. In economics, present value calculations are widely used, as well as in business.

If you are given the choice between getting $100 now, or $100 in one year, you will probably take the $100 now because that gives you money immediately. This is where Time Preference comes in. For example, if the $100 is worth $70 in one year, then the present value of the $100 one year in the future is $70. When you have money you have two options, you can save it or spend it. The benefit from saving money is that later on it will incur interest and that will give you more money down the road.

When money is evaluated for its present value in the future, it is called capitalization. So, let’s look at an example.

If you have the choice between $100 today and $100 in one year, you will probably choose the money now but if the money in a year earns 10 percent interest, then you can have $110 in one year, more than you would get now. The present value of the money at the future date is going to be $110.

Net Present Value

The net present value of a time series of money, both incoming and outgoing, is defined by the present values of the individual cash flows. Net Present Value is a central tool in discounted cash-flow and is used when determining the time value of money for long-term projects, such as budgeting within a company. By measuring the excess or shortfall of cash flows, in present terms, it is possible for companies to make good financial decisions.

Companies will use Net Present Value to determine if an investment or project is going to add value to the company. By using the calculations for Net Present Value, it is possible to determine the NPV and therefore, the value for the company as follows:

·   If the NPV is greater than zero, the investment would add money to the company and therefore the project should be accepted.

·   If the NPV is less than zero, then the investment will take value away from the firm and the project should be rejected.

·   If the NPV is equal to zero, then the investment will neither take money nor give money to the company. This means that decisions to accept or reject the project, should be based on other factors.

Future Value

The future value of money is how much a given sum of money will be worth at a specific time given the interest rate and the rate of return. The value does not include things like corrections for inflation.

Here is a brief example to illustrate future value of money. If you are given $100 today, it is worth $100, however in five years it will not be worth $100 because of the changing value of money. You can put the money into the bank and it will either grow or fall in value depending on interest. In addition, if you buy something today for $100, you may not be able to buy that same item for $100 because of inflation increasing the purchase price. Inflation can grow by about half a percent to one percent per year, and that will mean that the item will cost as much as five dollars more in five years.  As a result, economists will evaluate the true value of the money over a given period of time based on future value calculations. Companies and economists will look at the real interest rate to determine the purchasing power change over a period of time.

What Is GDP (Gross Domestic Product)?

GDP Definition

First Published: ADawnJournal.com March 20, 2010

Something that is vitally important for a country, and for the citizens of that country, is the gross domestic product, or GDP. The GDP is a basic measure of the health of a country’s economy because it is a measure of the overall economic output of that country. Similar to the profits of a company, the GDP shows whether or not a country is making money.

The GDP is essentially the market value of all the goods and services that are made within a country during one year and the higher the GDP, the higher the standard of living of that country.

In order to determine the GDP of a country, there are three different ways in which this can be done.

1.   The income approach

2.   The product/output approach

3.   The expenditure approach

The income approach works on the principle of having all the income of the producers in the country being equal the value of their products and the GDP is found by adding together all of the producers’ incomes.

The product approach is the most widely used of the approaches and it takes the sum of all enterprises to arrive at the GDP total for a country.

The expenditure approach uses the principle that products must be bought, so the value of a product must be equal to the expenditures of people when they buy items. This is not often used as an approach for GDP.

Standard of Living

As was mentioned earlier, the GDP of a country is tied closely with the standard of living of that country. While GDP per capita is not a measure of standard of living, it is an indicator of how the citizens of a country are doing financially. The better they are doing financially, the better the standard of living because they can buy more things to live on.

It is also important to note that the GDP per capita is not a measure of the personal income of a country’s citizens. It is possible for a GDP to increase while the income of the majority of the citizens in a country does not change by much, or may even go down. This has happened in the United States where during the 1990s, the income of the citizens went up by less than a percent, but the GDP went up by over three percent.

The biggest advantage of having a GDP per capita as an indicator of the standard of living of the citizens of a country is that it can be measured on a regular basis, often every year, or even every four months.

Of course, there is a disadvantage to using this method to determine standard of living and that is the fact that GDP per capita is not a measure of the standard of living, it is the measure of the economic health and activity of a country. An example of this is a country that can export 100 percent of its production, import nothing because it does not need to and that country will have a high GDP, but it will have a poor standard of living.

Real GDP and Nominal GDP

Real GDP is GDP in dollars that has not changed. This is usually done by taking the prices of a specific or base year. Read GDP is also referred as “constant dollar GDP”, “inflation protected GDP”, “constant price GDP” etc.

Nominal GDP is which has not been adjusted for price changes or inflation. Nominal GDP shows GDP in today’s or current prices. Nominal GDP may increase without increased economic output due to price increases.

The Highest GDPs on Earth

The world’s GDP is $60,971,477,000,000, which is $60.9 trillion, and of that, the European Union accounts for $18.3 trillion and the United States accounts for $14.4 trillion. Added together, the EU and the USA account for almost half of the world’s GDP. In terms of countries, not political groups like the EU, the United States has the highest GDP on Earth. The next highest is $10 trillion less, with Japan bringing in $4.9 trillion.

The top ten for GDP is as follows:

1.   United States   $14.4 trillion

2.   Japan    $4.9 trillion

3.   China    $4.3 trillion

4.   Germany   $3.6 trillion

5.   France   $2.8 trillion

6.   UK    $2.6 trillion

7.   Italy    $2.3 trillion

8.   Russia   $1.6 trillion

9.   Spain    $1.6 trillion

10.   Brazil    $1.5 trillion

The Lowest GDPs on Earth

Of course, there are plenty of countries that do not make much money in terms of GDP, and many of these countries make less in a year than some companies, and some of the richest people on Earth.

The bottom ten for GDP is as follows:

1.   Kiribati  $137 million

2.   Sao Tome  $176 million

3.   Tonga   $258 million

4.   Dominica  $364 million

5.   Guinea-Bissau $461 million

6.   Solomon Islands $473 million

7.   East Timor  $499 million

8.   Comoros  $532 million

9.   Samoa  $537 million

10.   Vanuatu  $573 million

What Is A Depression?

What Is A Recession Depression?

First Published: ADawnJournal.com March 23, 2010

When we talk about depression, we are not talking about a psychological condition. Instead, we are talking about an economic condition and it is a very serious one that has done a lot of damage in the past to the world’s economies. Naturally, the most famous is The Great Depression, but there have actually been several depressions, which we will cover.

What Is It?

A depression is a long-term downturn in economic activity of a country, or several countries. In contrast to a recession, a depression is much more severe and has long-term effects that go for longer than a recession. Depressions will typically last for several years, there will be very high levels of unemployment and the availability of credit will be much smaller. As well, there is usually a reduction in trading between countries, bankruptcies increase, and the currency of the countries affected typically becomes more volatile.

What Makes A Depression?

The National Bureau of Economic Research has stated that a depression is a period of time where there is a substantial and sustained fall in the ability of people and governments to purchase goods. As well, the GDP of a country needs to fall at least 10 percent and have a recession that lasts longer than two or more years, to qualify as being in a depression.

Depressions in The Past

There are several examples of depressions in the past, both recent and over a century ago. The degree of severity ranges, but the effects are felt by millions all over the planet.

The Great Depression

The most famous of all depressions is The Great Depression. During this depression, economies around the planet were affected greatly during the 1930s, and it is generally accepted that the catalyst for this depression was the Wall Street Crash of 1929. In the United States, the unemployment rate rose to 25 percent and the GDP of the country fell by 33 percent.

The Long Depression

Not as severe as the Great Depression, the Long Depression lasted for 23 years, or over twice as long as The Great Depression. One interesting point is that before The Great Depression, The Long Depression was called The Great Depression.

Depression of 1837

One interesting depression was one that lasted for five years, and many historians see this as the first Depression in recent history. It was The Panic of 1837, which was caused by the bursting of the real estate bubble in the United States on May 10, 1837, when banks stopped making payments in gold and silver. The Panic was short, but the depression it caused lasted for five years and was marked by banks failing and very high unemployment levels.

Regional Depressions

While the United States is generally seen as the place where depressions start or stop, many countries have had depressions of their own, including in the past 30 years. Some examples of these include:

·   In the 1980s, Argentina, Brazil, Chile and Mexico went through severe depressions in the 1980s when their GDPs fell by over 20 percent.

·   Argentina suffered a second depression that lasted from 1998 to 2002.

·   New Zealand suffered a long depression that lasted from 1974 to 1992.

·   Switzerland is currently in a depression that has lasted since 1973, but the qualification of this time as a depression is not accepted by all economists.

·   From 1980 to 2000, much of Sub-Sahara Africa suffered through a long and difficult depression.

·   The Soviet Union went through a depression that was seen as twice as severe as The Great Depression during most of the 1990s.

·   Finland went through a depression from 1989 to 1994 after the breakup of the Soviet Union. Norway and Sweden also had troubled economic times during this period.

Depressions are not something you want to go through. They are very difficult to deal with on a personal level, and for countries it can have disastrous results on a wide variety of industries. In a depression, there is less money to be spent on infrastructure and that means roads will decay at a faster rate. There is also less money to spend on police officers, which can cause crime to increase. In general, depressions are something every country wants to avoid, and thankfully, most are able to depending on how they react to poor economic times.

Australia Travel Blog: The Blue Mountains & The Three Sisters

Sydney Travel Blog: Part 11 – Blue Mountains’ Stunning Natural Beauty

2-Day Combo: Sydney City Tour + Sydney Harbour Lunch Cruise and Blue Mountains Day Trip

Sydney Travel Blog: Part 10 – Mountain Village Leura

When we left Leura for the Blue Mountains, we lost a couple of people. What had happened was that they failed to show up to catch the bus, the tour guide and operator waited a few more minutes, but finally left without them. I wondered how they would go back to Blue Mountains or Sydney; we were far out in the middle of nowhere.

After reaching the Blue Mountains Scenic World facility, I went inside to reach the observatory deck to have a first glimpse of the Three Sisters rock formation. The day was sunny and clear enough to see them. There are lots of paths and trails that can be explored without going too far. I noticed some huge artificial moving dinosaurs and eggs with sound simulation to make them more realistic. Kids loved those a lot.

I decided to finish lunch before going out in the mountains to get even closer to the Three Sisters. Lunch was not included and prices seemed to be not too inflated. I grabbed a chicken wrap and some water.

Once I started walking through the trails, the lush valley and lots of small creeks were some of the natural beauties I beheld. The tracks were going uphill and downhill, so it was easy to get tired after a few minutes.

The mountainous region was full of a variety of trees and shrubs, some of which were very tall. I was worried about getting lost by going too far, but I met some people from my tour and we stayed together. This helped a lot for taking pictures. I saw zipline cable cars moving through the sky; those people definitely had nicer views than those underneath.

We had to come back to our tour bus to take us to the Echo Point Lookout for a closer view of the Three Sisters, which is on the other side of the valley.

What Is An ETF (Exchange Traded Funds)?

Exchange-Traded Funds (ETF)

First Published: ADawnJournal.com March 28, 2010

What Is An ETF?

An ETF is a type of investment product that trades on an exchange like a stock. However, unlike a stock an ETF is not made of a single entity. An ETF is made of a group of investments. These groups can be a group of stock, bonds, natural resources, commodities, precious metals, etc. In most cases, an ETF follows an Index, as an Index is already made of a group of stock (or other investment products).

Advantages of ETFs

Lower Cost – The ongoing cost of holding ETFs (called Management Expenses Ratio or MER) is lower than mutual funds or index funds. For example, An ETF MER can be in the range of 0.25% – 1.00%; a mutual fund or an index fund MER can run in the range of 1.00% – 3.50%.

Flexibility – ETFs offer more flexibility as they trade on the stock exchange and can be bought or sold throughout the day during regular trading hours. Mutual funds do not offer this option, as they can be transacted using the NAV (Net Asset Value) which comes out at the end of the day.

Diversification – As ETFs are made of a basket of varieties of investments, they provide broad diversification and convenience. It would be time consuming, a lot of hassle, and almost impossible to get the same level of diversification with anything else.

You See What You Get – A major advantage of holding ETFs is that at least you get the return of the underlying index the ETF is tracking. You know what you are getting and you see what you get. With mutual funds, it is totally different. In general, regular mutual funds are made of many individual stocks (or other types of investment products) and most of the time you will have a hard time seeing what you are getting.

Tax Advantage – Tax liabilities are created when trading occurs in the fund. Active fund managers are always buying and selling securities in regular mutual funds. When you sell your mutual funds, fund managers have to sell securities to provide you with cash for your sell. However, this is not the case when you sell your ETFs. When you sell your ETFs, trading can occur between other ETF units holders (in-kind trade) – triggering no capital gain. This means ETFs do not need frequent trading to pay an investor who wants to redeem his part. Less trading creates less tax liability and thus, minimal to none capital gains. However, ETFs do need to trade occasionally. This type of trading occurs when index changes (as they are tracking index).

Easier Asset Allocation – ETFs let you easily manage asset allocation as you are able to see your entire ETFs in one place (your trading account) and thus track and manage asset allocation easily.

Low Maintenance – ETFs allow you to hold a broad range of indexes with minimal supervision. Studies show that experienced ETF investors beat most professional fund managers with a fraction of time and effort spent.

Disadvantages of ETFs

Requires Investment Knowledge – Buying ETFs is not as easy as mutual funds. You need to have a trading account and need to be some sort of investment savvy to hold ETFs.

Brokerage Fees – Buying ETFs incur brokerage commission or trading fees – just like stock, you pay fees to buy and to see. This makes buying ETFs for smaller amounts not justifiable.

No Dollar-Cost-Averaging – Since ETFs incur fees each time and buy and sell, it’s not a good vehicle for dollar cost averaging.

Market Timing – Since ETFs are easy to trade, it may tempt investors to do market timing (buy and sell to chase returns) via frequent trading and thus incurring a lots of transaction fees. ETFs work best for long time investors.

How ETFs Choose Its Holdings or Products

ETFs mainly use two methods to pick its holdings. These are called: Market-capitalization /Cap-weighted indexing and fundamental indexing.

Market-capitalization /Cap-weighted indexing replicates a market as-is. In this methodology, bigger companies have greater influence. Most common indexes such as the S&P/TSX Composite and the S&P 500 use this method. In Canada iShares and in the U.S. Vanguard use this method to operate many equity ETFs.

Fundamental indexing picks stocks by looking at fundamentals (such as earnings, book value, sales, dividends etc), not by size. Fundamental indexing proponents argue that Market-capitalization /Cap-weighted indexing overvalues larger and undervalues smaller equities. So to get true value, stocks’ fundamentals, not sizes should be looked at.

There are other methodologies such as price-weighted indexing, equal- weighted indexing, etc. If you are looking for the best indexing, there is no clear answer. You need to do a little research to find the best one that suits your needs. If you are looking for the cheapest one, Market-capitalization /Cap-weighted ETFs are usually the winner.

How to Buy or Sell ETFs

Since ETFs trade on exchanges, you need a trading account (discount brokerage account) to buy ETFs; just the same way you would buy stocks. In Invest Now, I have mentioned how to open a trading account at an ease.

Are There Any ETFs In Canada?

Canada is the country that invented ETF. |The world’s first ETF traded on the Toronto Stock Exchange in March 1990. Here are some ETF providers in Canada:

iShares Canada – The oldest and largest ETF provider in Canada.

Horizons – Horizons offers AlphaPro and betaPro ETFs. Horizons AlphaPro is the only ETF family that is actively managed ETF in Canada. Horizons BetaPro offers leveraged and inverse leveraged ETFs to profit in both bull and bear markets.

Claymore ETFs – Claymore offers various innovative intelligent investment strategies ETFs. This is the only company that offers ETFs that can do DRIPs (dividend reinvestment plan) in Canada.

BMO Exchange Traded Funds – New player in the ETF markets and the only major Canadian financial group to offer ETFs.

TMXMoney has a section on Exchange Traded Funds and I strongly encourage you to visit it.

How to Build an ETF Portfolio

I recommend you read these two articles I wrote.

How to Build an Investment Portfolio

What Is Asset Allocation?

A Dawn Portfolio (I am still working on this project and will add a link once done)

Once you are finished reading, do some more research and do some more reading from various other sources to have a good grasp of ETF. And then, if you are confident enough, construct a suitable portfolio that fits your needs. If you are not comfortable figuring out on your own, seek help from professional financial advisors.

NB – Currently, I do not have any articles giving ETF ideas, examples of Indices ETFs track and so on. I will be writing more on these in the future.

How Risky Are ETFs?

No investments come without risk (except some fixed income products like money market instruments, T – Bills, etc). However, due to the fact that ETFs provide a broad diversification with a wide variety of investments, you may be able to reduce some risk.

Last Word

As I mentioned in Invest Now, investment is an art. As such, it requires discipline, hard work and consistency. Do not blindly follow any ETF model portfolios or tools just because it looks cool. You are different than anyone else – make an educated decision based on your time horizon, risk tolerance, financial goals, and your overall financial situation.