What is Future Value (FV)?
Future value (FV) is the value of a current asset at a future date based on an assumed rate of growth. The future value (FV) is important to investors and financial planners as they use it to estimate how much an investment made today will be worth in the future. Knowing the future value enables investors to make sound investment decisions based on their anticipated needs. However, external economic factors, such as inflation, can adversely affect the future value of the asset by eroding its value.
Understanding Future Value
The FV calculation allows investors to predict, with varying degrees of accuracy, the amount of profit that can be generated by different investments. The amount of growth generated by holding a given amount in cash will likely be different than if that same amount were invested in stocks; so, the FV equation is used to compare multiple options.
Determining the FV of an asset can become complicated, depending on the type of asset. Also, the FV calculation is based on the assumption of a stable growth rate. If money is placed in a savings account with a guaranteed interest rate, then the FV is easy to determine accurately. However, investments in the stock market or other securities with a more volatile rate of return can present greater difficulty.
To understand the core concept, however, simple and compound interest rates are the most straightforward examples of the FV calculation.
- Future value (FV) is the value of a current asset at some point in the future based on an assumed growth rate.
- Investors are able to reasonably assume an investment's profit using the future value (FV) calculation.
- Determining the future value (FV) of a market investment can be challenging because of the market's volatility.
- There are two ways of calculating the future value (FV) of an asset: FV using simple interest and FV using compound interest.
Types of Future Value
Future Value Using Simple Annual Interest
The Future Value (FV) formula assumes a constant rate of growth and a single upfront payment left untouched for the duration of the investment. The FV calculation can be done one of two ways depending on the type of interest being earned. If an investment earns simple interest, then the Future Value (FV) formula is:
FV=I×(1+(R×T))where:I=Investment amountR=Interest rateT=Number of years
For example, assume a $1,000 investment is held for five years in a savings account with 10% simple interest paid annually. In this case, the FV of the $1,000 initial investment is $1,000 * [1 + (0.10 * 5)], or $1,500.
Future Value Using Compounded Annual Interest
With simple interest, it is assumed that the interest rate is earned only on the initial investment. With compounded interest, the rate is applied to each period's cumulative account balance. In the example above, the first year of investment earns 10% * $1,000, or $100, in interest. The following year, however, the account total is $1,100 rather than $1,000; so, to calculate compounded interest, the 10% interest rate is applied to the full balance for second-year interest earnings of 10% * $1,100, or $110.
The formula for the Future Value (FV) of an investment earning compounding interest is:
FV=I×(1+RT)where:I=Investment amountR=Interest rateT=Number of years
Using the above example, the same $1,000 invested for five years in a savings account with a 10% compounding interest rate would have an FV of $1,000 * [(1 + 0.10)5], or $1,610.51.