What is Future Value (FV)?

Calculating future value is like planning a road trip…

When you’re going on a road trip, you can use several factors to figure out exactly when you’ll arrive at your final destination. You might consider the distance you have to drive, the speed at which you’re driving, as well as how many breaks you plan to take along the way. Similarly, investors can estimate the future value of an investment by taking into account various factors. The calculation of future value is based on assumptions, meaning there’s no guarantee you’ll see those returns.

Future value refers to the amount that investors might expect to earn on an asset or amount of cash by a particular date in the future. Estimating the future worth of a current investment, future value can be a useful tool in determining if a particular investment is beneficial. Investors can calculate the future value of an investment by using its present value, rate of growth, and the number of years in the future they’d like to plan for.

Suppose you were saving for the downpayment on a home, and you were keeping the money in a high-yield savings account. You’d want to know how much interest your savings will earn over the next few years. In other words, you’d want to know its future value. You could easily figure out how much you’d earn using a future value formula that factors in your account’s interest rate, the amount of money in the account, and the number of years until you plan to use the money.

There are two primary methods someone might use to calculate future value: simple interest and compound interest.

Simple interest is a method of calculating future value in which the interest rate only applies to the principal, or the initial deposit amount.

For example, suppose a corporation issued bonds (a type of debt security that companies sell to investors) to raise money for a project. Often the issuers of bonds give investors regular interest payments — usually calculated based on simple interest. Let’s say the bonds were sold with a principal of $1,000 and an interest rate of 3%. When it comes time for the issuer to make an interest payment, it would be based on the principal of $1,000.

Simple interest is the most common type of interest for different types of debt. As a consumer, you might encounter simple interest when you borrow money for a mortgage or auto loan. As an investor, you might be on the receiving end of simple interest when you invest in bonds.

Compound interest is a method of calculating future value in which the interest earned is added to the principal each period. That way, the next time the investment earns interest, the rate is applied to the principal plus whatever interest the investment had previously earned.

Compound interest is the type of growth an investor can expect in many types of investments, including savings accounts and Certificates of Deposit (a type of account that pays a higher interest rate as long as you keep your money in it for a particular period). While stocks don’t pay interest, investors can also use the compound interest formula to estimate long-term returns from stock holdings if they plan to reinvest the dividends and capital gains. Knowing this information can be valuable for investors to estimate how much money they may have in the future. That being said, it’s just an estimate. There’s no guarantee you’ll experience the returns you expect.

Of the two types of interest, compound interest allows an investment to grow the fastest. Simple interest only ever applies to the principal (or any money the investor has proactively added) of the investment. As a result, the investment doesn’t increase exponentially. In the case of compound interest, however, the interest applies to a greater and greater amount each period (assuming the investor hasn’t withdrawn money from the investment).

Present value is one of the most important factors to know when it comes to calculating the future value of an investment. The present value of any particular investment is its current value. Suppose someone had $1,000 that they planned to put into an investment account. The present value of that investment would be $1,000. This value is the starting point for determining how an investment will grow.

Present value can also be useful for financial planning. If someone wanted to understand how much they would need to invest in order to achieve an investment goal, they could use the future value of the investment to determine the present value of how much they would need to start with.

Figuring out the future value of an investment is a fairly simple calculation, and investors can adjust it to account for the type of investment they’re dealing with.

To calculate the future value of an investment with simple interest, you’ll need to know the investment’s present value, its interest rate, and how many years into the future you want to forecast. In this formula:

FV = Future value PV = Present value i = Interest rate n = Number of years

The formula for calculating simple interest is:

FV = PV (1+in)

Suppose you had an investment of $100 that was earning simple interest at a rate of 5%. If you wanted to estimate how much the investment could grow after three years, you’d start by multiplying the rate of 5% (or 0.05) by three years, which results in a total of 0.15. Next, add 1 for a result of 1.15. Finally, multiply the total amount by the principal of $100. The total amount you would end up with is $115, or $15 in interest. The formula for that scenario looks like this:

FV = $100 (1+.05x3)

Calculating compound interest is a bit more complicated, because the interest you earn begins to earn interest as well. Calculating compound interest requires the same information needed for simple interest: the principal, the interest rate, and the number of periods. In this formula:

FV = Future value PV = Present value i = Interest rate n = Number of years

The formula for compound interest is:

FV = PV (1+i)^n

Let’s use our example of the $100 with an interest rate of 5% that grows for three years. Rather than multiplying the interest rate by the number of years, you’d calculate 1 plus the interest rate to the power of the number of years. That calculation looks like this:

FV = $100 (1+.05)^3

Using this formula, you can determine that your future value is $115.76.

This formula can be adjusted depending on the compounding frequency (meaning how often the earned interest is added to the principal). If you have an investment with interest that compounds annually, you’d calculate based on the number of years you’ll hold the investment. For an investment that compounds monthly, you’d calculate based on the number of months you plan to hold the investment.

Suppose you’re calculating the future value of an annuity (an investment that pays a fixed income, often during retirement) that you make regular contributions to. To calculate the future value of th annuity, you’d need the following information:

• FV = Future value
• A = Annuity payments to be contributed
• r = Rate of return
• n = Number of periods (years)

The formula to calculate annuity is:

FV A = A * {(1 + r)^n - 1} / r