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Future Value: Definition, Formula, How to calculate, Examples

Last updated 04/09/2024 by

Michael Olusoji

Edited by

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Summary:
Future value is an important idea in personal finance and investment that helps people comprehend how much their money will be worth in the future. The idea is based on the time value of money, which holds that money is worth more now than it will be later.
The future value formula considers the present value of money, the interest rate, and the time period over which the investment will receive interest. Understanding future value can help you make smarter decisions about your investment options and estimate the possible returns on your assets.

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What is future value?

Future value is the amount of money an investment will be worth after a specific period of time if permitted to grow at a certain interest rate. It is an important idea to comprehend in order to make informed decisions regarding saving, investing, and retirement planning.
Future value is an important estimate in financial planning because it enables individuals and corporations to make current decisions based on future estimates.
Individuals can calculate the future worth of an investment to determine how much money they need to save or invest today in order to achieve their desired financial goals in the future.
Future value formula and computation
The future value formula is a mathematical equation used to compute the future worth of an investment or cash flow based on its present value, interest rate, and holding period.
The future value formula can be expressed in several different ways, but the most common form is:
FV = PV x (1 + r)n
Where:
FV = Future Value
PV = Present Value
r = Interest Rate
n = Number of Periods
To use the formula, the present value of the investment or cash flow is multiplied by the sum of 1 plus the interest rate, raised to the power of the number of periods the investment is held. The result is the estimated future value of the investment.
For example, suppose an individual invests $1,000 in a savings account that pays an annual interest rate of 5%, compounded annually, for five years. Using the future value formula, the future value of the investment can be calculated as follows:
FV = $1,000 x (1 + 0.05)5
FV = $1,276.28
This means that if the interest rate remains constant and the investment is neither taken or reinvested, the investment will be worth $1,276.28 after five years.
The future value formula can be used to any investment or cash flow, including stocks, bonds, mutual funds, and other financial instruments.
It is an important financial planning tool because it helps individuals and businesses to predict the future worth of their investments and make informed decisions about how to deploy their resources over time.

Examples of future value

  • Investing in a savings account: Assume a person deposits $5,000 into a savings account with a 2% annual interest rate that is compounded monthly.
    After ten years, the investment’s future worth can be computed as follows: FV = $5,000 x (1 + 0.02/12)^(12×10)
    FV = $5,613.53
  • Investing in a mutual fund: Assume an individual invests $10,000 in a mutual fund with a 20-year compounded annual return of 7%.
    After 20 years, the investment’s future worth can be computed as follows: FV = $10,000 x (1 + 0.07)^20
  • Investing in a stock portfolio: Suppose an individual invests $50,000 in a diversified stock portfolio that has an average annual return of 10%, compounded annually, for 30 years. After 30 years, the future value of the investment can be calculated as follows:
    FV = $50,000 x (1 + 0.10)^30
    FV = $1,368,363.81
These examples demonstrate how the future value formula can be used to estimate the potential return on different types of investments over time. It is important to note that the actual return on an investment may differ from the estimated future value due to changes in interest rates, market conditions, and other factors.

Factors affecting future value

  • Interest rate: The interest rate is a key factor that affects the future value of an investment. A higher interest rate will result in a higher future value, while a lower interest rate will result in a lower future value.
  • Compounding frequency: The frequency at which interest is compounded can also affect the future value of an investment. More frequent compounding, such as daily or monthly, will result in a higher future value than less frequent compounding, such as annually.
  • Time horizon: The length of time an investment is held can significantly affect its future value. The longer the time horizon, the more time the investment has to grow, resulting in a higher future value.
Investment amount: The amount of money invested also affects the future value of an investment. A larger investment will result in a higher future value, while a smaller investment will result in a lower future value.
  • Inflation: Inflation can reduce the purchasing power of an investment over time, which can affect its future value. It is important to account for inflation when calculating the future value of an investment.
  • Investment risk: The risk associated with an investment can also affect its future value. Investments with higher risk may have the potential for higher returns, but also carry a higher risk of loss. Lower-risk investments may have lower returns, but also carry a lower risk of loss.
  • Fees and taxes: Fees and taxes associated with an investment can also affect its future value. Higher fees and taxes can reduce the overall return on an investment, resulting in a lower future value.

Key takeaways

  • Future Value (FV) is the value of an investment at a specified point in the future, based on a predetermined interest rate.
  • The formula to calculate FV is FV = PV x (1 + r)^n, where PV is the present value of the investment, r is the interest rate, and n is the number of compounding periods.
  • FV can be calculated for any type of investment, such as bonds, stocks, or mutual funds, and can help individuals determine the potential growth of their investments over time.
  • Compounding is a critical factor in calculating FV, as it is the process of reinvesting the interest earned on an investment back into the investment.
  • To maximize FV, individuals can consider investing in high-yield investment vehicles, such as stocks or mutual funds, and increase the frequency of compounding by reinvesting dividends or interest earned.
  • Inflation is an important consideration when calculating FV, as it can erode the purchasing power of the investment over time. It is important to factor in inflation when projecting future values.

SuperMoney may receive compensation from some or all of the companies featured, and the order of results are influenced by advertising bids, with exception for mortgage and home lending related products. Learn more

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