Future Value (FV)

Future Value (FV)

What is future value (FV)?

Future value (FV) is the value of a current asset at a future date based on an assumed growth rate. Future value (VF) is important to investors and financial planners because they use it to estimate the value of an investment made today in the future. Knowing the future value allows investors to make good investment decisions based on their anticipated needs. However, external economic factors, such as inflation, can affect the future value of the asset by eroding its value.

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Future value

Understanding future value

Calculating the FV 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 of cash will likely be different from if that same amount were invested in stocks; thus, the equation FV is used to compare several options.

Determining the FV of an asset can become complicated, depending on the type of asset. In addition, the calculation of VF is based on the assumption of a stable growth rate. If the money is placed in a savings account with a guaranteed interest rate, the FV is easy to accurately determine. However, investing in the stock market or other securities with a more volatile rate of return may present more difficulties.

To understand the basic concept, however, simple and compound interest rates are the simplest examples of calculating VA.

Key points to remember

  • Future value (FV) is the value of a current asset at some point in the future based on an assumed growth rate.
  • Investors can reasonably assume the benefit of an investment using the calculation of future value (FV).
  • Determining the future value (VF) of a market investment can be difficult due to market volatility.
  • There are two ways to calculate 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 growth rate and a single initial payment left intact for the duration of the investment. The calculation of the FV can be done in two ways depending on the type of interest earned. If an investment earns simple interest, the Future Value (FV) formula is:

FV = I x (1 + (R x T).
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or:

  • I = investment amount
  • R = interest rate
  • T = number of years

TheFor example, suppose an investment of $ 1,000 is held for five years in a savings account with 10% simple interest paid annually. In this case, the FV of the initial investment of $ 1,000 is $ 1,000 * [1 + (0.10 * 5)]or $ 1,500.

Future value using compound annual interest

With simple interest, it is assumed that the interest rate is only earned on the initial investment. With compound interest, the rate is applied to the cumulative balance for each period. In the example above, the first year of investment earns 10% * $ 1,000, or $ 100, in interest. The following year, however, the account total was $ 1,100 instead of $ 1,000; thus, to calculate compound interest, the interest rate of 10% is applied to the full balance of second-year credit interest of 10% * $ 1,100, or $ 110.

The formula for the future value (FV) of an investment that generates compound interest is as follows:

FV (compound interest)

FV = I x (1 + R) ^ T.
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or:

  • I = investment amount
  • R = interest rate
  • T = number of years

Using the example above, the same $ 1,000 invested for five years in a savings account with a compound interest rate of 10% would have an FV of $ 1,000 *[(1+010)[(1+010)[(1+010)[(1+010)5]or $ 1610.51.

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