Join Jim Stice for an in-depth discussion in this video The time value of candy, part of Using the Time Value of Money to Make Financial Decisions.
- All right, let's do a little thought experiment. - Okay. - Imagine that you are a three-year-old child. - Okay, I've got it. I'm a three-year-old child. I'll imagine that I'm my granddaughter Sophie. She's three. - Perfect. I offer you one piece of chocolate now or one piece of chocolate tomorrow. Which would you take? - Oh, please. I'll take the chocolate now. - Exactly. Any child understands what I will call the time value of candy. Candy now is worth more than candy in the future. What if I offer you one piece of chocolate now or five pieces if you wait till tomorrow? - A three year old would probably still take the one piece now.
- I agree. For a young child, the future is such an unpredictable and vague place that it makes sense to take your candy now. In fact, an important part of growing up is learning that planning an action now have predictable consequences for the future. So, let's change the example. Imagine that you are you. I offer you the following deal, 100 pieces of chocolate now or you can go without chocolate for an entire year and I give you 100 pieces of chocolate one year from now. - I'll take the 100 pieces of chocolate now.
- Okay, 100 pieces now or 105 pieces one year from now. - I'll still take the 100 pieces now. - 120 pieces a year from now? - Now, this is getting tough. I'd probably still take the 100 pieces now. - All right, 100 pieces now or 200 pieces one year from now. - See, now you've got me. I'll wait, and I'll take the 200 pieces one year from now. - Excellent. You see that people prefer candy or money now to candy or money in the future. But there is some extra amount in the future, some amount of interest, that can cause you to wait.
In this case, your chocolate interest rate was 100%. I had to agree to double your chocolate to get you to wait one year. - Hey, I like chocolate.
Learn more about interest rates and investments in the Stices' Finance Fundamentals course.