What is future value (FV)?
Future value (FV) is the estimated future value of an asset based on a projected growth rate. Investors and financial planners evaluate the future value of a current investment.
Knowing their future worth helps investors make intelligent investments depending on their requirements. External economic variables like inflation might erode the asset’s future worth.
Compare the future value to the present value (PV).
Knowing Future Value
Investors may forecast investment profits with variable degrees of accuracy using future value computation. The future value calculation compares numerous possibilities since cash growth may differ from equity growth.
Depending on the asset, estimating its future worth might be difficult. The future value calculation assumes stable growth. A fixed interest rate in a savings account makes predicting the future’s worth easier. However, the stock market and other volatile investments might be riskier.
However, primary and compound interest rates are the most accessible for future value calculations.
To assess how your savings may become a home down payment, automobile down payment, or tuition funds, utilize the future value formula.
Formula for Future Value
Calculating Future Value with Simple Annual Interest
The future value calculation assumes steady growth and a single upfront payment throughout the investment. Two methods can be used to calculate future value, depending on the type of interest. If an investment earns simple interest, the FV formula is:
FV=I×(1+(R×T))
Where:
I = Investment amount
R = Interest rate
T = Years
Suppose a $1,000 savings account investment earns 10% simple interest for five years. The initial investment of $1,000 has an FV of $1,500, calculated as $1,000 × [1 + (0.10 x 5)].
Calculating Future Value with Compound Annual Interest
Put, essential interest assumes that just the initial investment earns interest. Compounded interest applies the rate to each period’s cumulative account balance. The first year of investing generates $100 in interest, calculated as 10% × $1,000. To compute compounded interest for the second year, apply the 10% interest rate to the whole sum, resulting in $110 in profits since the account total is $1,100 instead of $1,000.
The formula for calculating the FV of a compound interest investment is:
FV=I×(1+R)^T
Where:
I = Investment amount
R = Interest rate
T = Years
Investing $1,000 in a savings account with a 10% compound interest rate for five years yields an FV of $1,610.51 (from the preceding example).
Are you worried about the market? Future value may assess how much $1,000 invested now is worth if the market loses 5% per year for two years.
Pros and Cons of Future Value
Some situations benefit from future value. However, the computation has limits and may not be acceptable in some instances.
Advantages of Future Value
- Future worth facilitates planning. A firm or investor may know what they have and make predictions. Combining this information helps people prepare for the future and understand their finances. A homeowner saving $100,000 for a down payment might estimate the time required to attain this goal using future value.
- Future value simplifies comparisons. Suppose an investor compares two investments. One must spend $5,000 to earn 10% for three years. The other needs $3,000 and returns 5%, 10%, and 35% in years one, two, and three. An investor can only determine whether the investment will produce more money by estimating future values and comparing results.
- Estimates make future value easier to determine. Future value does not require complex or actual numbers. Anyone can utilize hypothetical future value because it relies on estimations. For instance, the homebuyer above may compute the future worth of their $100,000 savings using their expected monthly contributions, interest rate, and savings duration.
Downsides of Future Value
- Most future values imply steady growth. The formulas above utilize one interest rate. Calculating future value with variable interest rates becomes more complicated and less clear. A simplistic calculation using merely a rate may have unrealistic parameters since growth may not be linear or consistent year-over-year.
- Future value assumptions may fail. Due to future assumptions, future value estimations are projections that may not occur. Investors may estimate their portfolio worth based on an 8% annual market return. Previous future value calculations are useless if the market fails to achieve that predicted return.
- Future value comparisons may fail. Future value is the future financial value of something. Comparing two projects has limits. Consider this: an investor can invest $10,000 for a 1% return or $100 for 700%. The first choice seems better since it has more significant future worth, but it ignores the original expenditure.
Future Value Pros/Cons
Pros
- Estimates make it easier to compute.
- Lump sum or basic cash flow future value estimates may be straightforward.
- Future value can decide if an investment fulfills a goal alone.
- Future value applies to any cash flow, return, or investment structure.
Cons
- Estimates may quickly invalidate conclusions.
- Infrequent cash flow or annuity future value estimates might be tricky.
- Future value alone cannot be selected between mutually incompatible initiatives.
- Many future value models imply perpetual growth, which is unrealistic.
Future vs. Present Value
Future value invariably relates to current worth. Present value calculates what something in the future will be worth now, whereas future value calculates its future value.
Both models use financial principles, including discount or growth rates, compounding periods, beginning investments, etc. All components are interdependent and affect each other’s calculations. Consider owning $1,000 now and anticipating 5% growth next year.
$1,050 Future Value: $1,000 * (1 + 5%)^1
To calculate today’s value of anything in the future, reverse the formula. Thus, using the same investing assumptions, $1,050 is worth $1,000 today.
$1,050 / (1 + 5%)^1 = $1,000 Present Value.
The future value may become current value and vice versa; simply shifting directions and investing $1,000 at 5% yields $1,050, and earning $1,000 yields $1,000.
Annuity vs. Annuity Due
Understand how payment scheduling affects annuity future value calculations. Ordinary annuities are paid after the period. Starting payments are annuity due.
Example
The IRS levies a Failure to File Penalty on taxpayers who miss the due date for filing their return. Each month, if a tax return is late, the Penalty is 5% of unpaid taxes up to 25%. The IRS charges interest on Failure to Pay fines.
A taxpayer who submitted their return late and is subject to the 5% penalty may readily compute the future worth of their unpaid taxes depending on their fee’s increase rate.
A taxpayer may expect to file their return one month late. The taxpayer anticipates $500 in taxes. The taxpayer can compute the future worth of their $500 tax liability assuming a one-month 5% penalty. The 5% penalty increases the $500 tax obligation to $525 in the future.
Consider another $950-discounted zero-coupon bond. The bond has two years to maturity and an 8% yield goal. Investors can use current factors to determine the bond’s value in two years. In two years, this bond will be worth $1,108.08 ($950 * (1 + 8%)^2). At TreasuryDirect, the U.S. Department of Treasury bond website, investors may use calculators to predict savings bond growth and value.
What’s Future Worth?
Financial concept future value (FV) values an asset based on expected future interest rates or cashflows. Investors may benefit from knowing their investment in five years, given a projected rate of return. Future value involves taking the current investment value, applying predicted growth, and computing the future value.
How do we calculate future value?
There are various future value formulae. All determine future value by forecasting cashflows based on expected growth rates. Calculating the future value for a single lump amount is simpler (principal * (1 + rate) ^ periods), but annuities, cash flows, and interest rates are more complicated.
Why Use Future Value?
Planning uses the future value to estimate investment, cash flow, and expenditure. Investors decide whether to invest based on future worth. Future value can also assess risk, estimate interest-bearing expenses, or set a savings goal to see if enough will be saved given the present savings rate and predicted return.
The Future Value of an Annuity?
The future value of an annuity is the worth of repeating payments at a future date, assuming a specific return or discount rate. Higher discount rates increase annuity value.
Calculating annuity FV:
FV = PMT x (1+r)n – 1/r
Where:
FV = Future value of annuity stream.
PMT = Annuity payment dollar amount.
r = Discount (interest) rate
The number of payment periods is n.
How Does Future Value Differ From Present?
Future value estimates the future value of a situation. Future value estimates the $1,000 invested at 10% for five years. Present value estimates the value of a future scenario now. Present value estimates how much you must invest 10% for five years to get $1,000.
Bottom Line
Finance relies on the time value of money to calculate future value (FV). A dollar now is worth more than a dollar tomorrow. Using future value, one can estimate the worth of money, investment, or cash flow. Multiplying a sum of money now by the predicted return rate over the expected period gives its future worth. Future value works oppositely to discounting future cash flows to the present.
Conclusion
- An anticipated growth rate determines an asset’s future value (FV).
- The FV calculation lets investors estimate investment profits.
- Market volatility and uncertainty about future investing circumstances make investment FV determination difficult.
- There are two techniques to calculate asset FV: simple interest and compound interest.
- The former assesses what something will be worth in the future, whereas the latter determines its current value.
