The value of money changes over time, owing to its ability to earn interest. Its value today isn’t the same as its future value.
This concept, that the value of money changes over time, is central to corporate and personal finance. But it’s also a very simple one.
Let’s say that you put $100 in the bank today, and you don’t plan to make a withdraw for three years. To gain your business, the bank agrees to pay you an annual interest rate of 10%. (In reality, the yield on most savings accounts is much lower.) At the end of the first year, you’ll have $110. During the second year, you’ll earn 10% interest on that sum, for a total of $11 in interest. Heading into year three, you’ll have $121, on which you’ll earn $12.10 in interest. When you finally withdraw your funds, you’ll receive $133.10.
Therefore, the future value of investing $100 today, given a 10% annual interest rate over three years, is $133.10.
Interest rates as low as 5.4%
The Future Value Formula
The calculation above is a straightforward one that uses nice round numbers.
Now, let’s say you’re considering investing $25,000 of your hard-earned money. The account will pay you 6% annually. You’ll withdraw the funds in 18 years. And you plan to add $500 to the account each year.
You can certainly calculate the total you’ll have at the beginning and end of each, just like we did above. However, it’s likely to take a while.
If you’re not ready to dig into the math, this calculator will do the work for you.
Practical Uses For The Future Value Formula
The future value formula can come in handy in many areas of your financial life.
- Use Case #1: Let’s say you’re planning to invest $10,000 of your money in an index fund. You expect a 6% annual return, and you want to know what your investment will look like in 10 years. The future value formula will tell you.
- Use Case #2: Today, you have about $250,000 in an investment account. You know that you want to retire in about 20 years, and you expect that you’ll need a minimum of $1,000,000 to guarantee a comfortable lifestyle in retirement. Historically, your portfolio has returned about 7% each year. You can use the future value formula to determine what your investment might look like when you’re ready to retire, assuming you get about the same rate of return moving forward.
What This Calculator Will Tell You
This calculator will tell you the future value of an investment, assuming you know the following:
- The present value or current sum
- The annual rate of return
- The length of time or number of periods over which the investment will accrue interest
- Any additional amount that you’ll invest in each period
What This Calculator Won’t Tell You
There are many types of investments. Some pay interest at a fixed rate. With others, the rate of return will depend on market conditions. It goes almost without saying that this calculator, and others like it, will provide more accurate projections for the former. With the latter, the value of your investment will fluctuate, based on company performance and economic conditions, among other factors. It’s possible only to estimate the future value, using assumptions about expected performance of the investment.