Wananchi Opinion: This is why you should charge interest on money

Money you have in hand today is worth more than the same amount promised later because cash you hold can earn interest, pay down debt, fund a business, or cover an emergency.

This idea around the time value of money guides nearly every financial decision.

Time itself puts a price on money: people who receive and invest cash early gain a reward, while those who wait or ignore this cost end up paying for the delay.

At the heart of the time value of money is opportunity cost. If you get KES 100,000 today and place it in a fund earning  8  percent a year, after twelve months you’ll have about KES 108,000.

The extra KES 8,000 shows what you would lose if you agreed to wait a year for the same KES 100,000.

For a fair bargain, any payment in a year should equal that future value-around KES 108,000.

If someone offers only KES 100,000 next year, you would be better off rejecting the deal or charging interest until the delayed payment matches what your money could have earned.

The same logic applies in everyday shopping. Suppose a shop sells a refrigerator for KES 60,000 in cash or KES 10,000 now plus six-monthly instalments of KES 9,000, a total of KES 64,000.

The difference looks small, just KES 4,000, but each future KES 9,000 payment should be discounted at whatever return you could earn elsewhere, say the same 8 percent.

Added together, the discounted payments usually show that the instalment plan costs far more than it first appears.

Time value of money also helps you plan long‑term goals. If you will need KES 1 million for university fees in ten years and you expect to earn 9 percent a year, the present value of that goal is about KES 422,000.

A lump sum of KES 422,000 invested now should grow to the target. If you do not have that much today, you can instead calculate a monthly deposit that will reach the same future amount. Discounting turns a distant target into a clear, manageable plan.

Businesses and governments use the same principle. Before building a factory, a company forecasts profits and costs and discounts each cash flow at its cost of capital to see if the net present value is positive.

Governments test roads, power plants, and hospitals the same way, making sure taxpayer funds produce benefits worth more today than the spending.

When a central bank cuts interest rates, it lowers the discount factor across the economy; lower rates raise present values and push up stock and bond prices, which is why markets react sharply to rate news.

Bond prices equal the discounted value of future coupon payments plus principal, and share analysts do something similar by discounting expected dividends or free cash flows, often with rates from the Capital Asset Pricing Model.

A lower discount rate from a central‑bank cut means higher present values and usually higher asset prices, so investors pay close attention to monetary‑policy announcements.

People, however, are not perfect calculators. Behavioural economists show we often overvalue immediate pleasure- a bias called hyperbolic discounting.

Expensive instant mobile‑money loans charging triple‑digit annual rates illustrate this mistake. Framing choices in present‑value terms can help: seeing a KES 10,000 impulse buy as “KES 40,000 less in my retirement fund” (assuming 7 percent growth over twenty years) can cool the urge.

In the end, time changes what money is worth. Whether you are shopping, borrowing, investing, or planning retirement, remembering that cash now is usually better than cash later will steer you toward smarter, more profitable decisions.

Mr. Abol Kings is a personal finance advisor and a former banker