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VMC: What Is Future Value? was originally published here.
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Definition of Future Value
- It is the value of a current asset at a specific time in the future calculated based on an assumed growth rate.
- The value of money includes time value; therefore, the future value is expected to be greater than the present value of the investment, considering the growth in investment.
What Impacts Future Value?
- Factors such as inflation and the rate of return affect the value of money. In turn, that affects the future value of an asset.
- The FV is calculated based on the interest earned on investments.
How To Calculate FV?
- There are two different ways to calculate the future based on the different interests earned on an asset.
- Simple Annual Interest Formula:
FV = I * (1 + (R * T))
(Where FV = future value, I = initial investment, R = interest rate, and T = investment period.)
- Compound Annual Interest Formula:
FV = I * (1 + R)^T
(Where FV = future value, I = initial investment, R = interest rate, and T = investment period.)
Why is Future Value Important?
- Investors use FV to estimate how much their investment today will be worth at a future date.
- Estimating FV helps investors make critical investment decisions that check all their project requirements.
- Investors can calculate the amount of profit that they will receive from the investments they make using FV.
FV in Practice
- The FV in practice is not a guaranteed measure, but rather an estimate.
- There is an underlying assumption that a rate of return is earned on the funds over the time period. In practice, interest rates can fluctuate all the time.
- Adjustments for inflation can also impact the rate of return on investment.
- The calculation of FV is also not always accurate; it is possible to calculate an accurate FV of an asset with a steady interest rate.
- Assets with fluctuating interest rates require a more complex FV calculation.
- Let’s say you have $1,000 and would like to invest it at an interest rate of 5%. How much would you have in 10 years?
- 1,000 * (1 + 0.05) ^ 10 = $1,628.89
- Therefore, you would have $1,628.89 in 10 years.
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