The time value of money is also related to the concepts of inflation and purchasing power. Both factors need to be taken into consideration along with whatever rate of return may be realized by investing the money.
Why is this important? Because inflation constantly erodes the value, and therefore the purchasing power, of money. It is best exemplified by the prices of commodities such as gas or food. If, for example, you were given a certificate for $100 of free gasoline in 1990, you could have bought a lot more gallons of gas than you could have if you were given $100 of free gas a decade later.
Inflation and purchasing power must be factored in when you invest money because to calculate your real return on an investment, you must subtract the rate of inflation from whatever percentage return you earn on your money.
If the rate of inflation is actually higher than the rate of your investment return, then even though your investment shows a nominal positive return, you are actually losing money in terms of purchasing power. For example, if you earn 10% on investments, but the rate of inflation is 15%, you’re actually losing 5% in purchasing power each year (10% – 15% = -5%).