The concept of the time value of money takes into account that a dollar received today is worth more than a dollar received in the future. Financial planners must routinely calculate the future value of investments in order to help clients plan for goals such as retirement.


Future Value
When planning an investment strategy, it is useful to be able to predict what an investment is likely to be worth in the future, taking the impact of compound interest into account. This formula allows you (or your calculator) to do just that:
 

Pn = P0(1+r)n
P0 is the original amount invested
Pnis the future value of P0
nis the number of compounding periods (years, months, etc.)
r is the rate of interest


As the following examples illustrate, when you increase the frequency of compounding, you also increase the future value of your investment.

How much will an investment, (worth $10,000 today), be worth 10 years from now at a rate of 9%?

P0 = $10,000
Pn is the future value of P0
n = 10 years
r = 9%

Example 1: If interest is compounded annually, the future value (Pn) is $23,674.

10,000*(1.09)10*1 = $23,674


Example 2: If interest is compounded monthly, the future value (Pn) is $24,514.

10,000*(1+(0.09/12)10*12 = $24,514

The same concepts can help you to calculate the amount needed today to reach the future value of a desired investment. For example, if a client wishes to retire with $1 million, it would be useful to know how much she needs to save each year to reach that goal.

You can simply reverse the future value formula to calculate the present value required:
 

P0 = Pn / (1+ r) n

 

Net Present Value (NPV)

Related Articles
  1. Investing

    Calculating Future Value

    Future value is the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.
  2. Investing

    Learn Simple and Compound Interest

    Interest is defined as the cost of borrowing money, and depending on how it is calculated, it can be classified as simple interest or compound interest.
  3. Investing

    Understanding the Power of Compound Interest

    Understanding compound interest is important for both investing and borrowing money.
  4. Investing

    Time Value Of Money: Determining Your Future Worth

    Determining monthly contributions to college funds, retirement plans or savings is easy with this calculation.
  5. Investing

    Accelerating Returns With Continuous Compounding

    Investopedia explains the natural log and exponential functions used to calculate this value.
  6. Retirement

    Using Compounding to Boost Retirement Savings

    Allowing growth on your investments to compound over time gives you immense returns when saving for retirement.
  7. Retirement

    How to Calculate the Value of Annuities

    Here's everything you need to account for when calculating the present and future value of annuities.
  8. Investing

    How to Avoid the 3 Most Common Investor Pitfalls

    Whether you're about to start investing or are already doing so, avoid these investor pitfalls.
  9. Managing Wealth

    Retirement: Saving First Million Is the Hardest

    Once retirement savings reach $1 million, building wealth becomes much easier. Here's why.
Frequently Asked Questions
  1. What Are the Components of a Risk Premium?

    Learn the five main risks that comprise the risk premium and how they affect investors.
  2. What Is an Odd-Lot Buyback?

    Odd-lot buybacks involve lots of less than 100 shares. Learn how companies get these shares back.
  3. How is a company's share price determined?

    Understand the concept behind the Gordon growth model and what it is used to measure. Learn how a company's share price is ...
  4. What is the difference between real estate and real property?

    Understand how real estate is legally different from real property and the implications of that difference for each property ...
Trading Center