How to Calculate the Future Value of an Investment

The future value of an investment is considered one of the simplest calculations in finance. It allows you to determine the value of an investment in the future. The future value calculation is based on the fundamental principle of the time value of money, which states that a dollar in your hand today is worth more than a dollar you will receive tomorrow.

What is the future value of an investment?

The future value allows a single amount of money for companies to assess an investment, taking into account the current market interest rate and the duration of the investment.

For example: you deposit $100 in the bank, and the bank applies interest to your deposit every quarter. While your money remains in the deposit, that $100 will continue to grow based on the interest rate on the deposit and the duration of the loan.

If an employer deposits a continuous amount into a bank account, those payments are called ordinary annuities.

How to calculate future value?

There are three methods you can use to calculate the future value of an investment. The first method is to use the mathematical formula. The other two methods are also based on the formula as they are considered the foundation of the principle of the time value of money.

Using the future value formula:

FV = PV + I

Where:

PV = the present value of the investment or the initial value

FV = the future value of the investment after t or the number of periods in which the deposit is invested

I = interest earned on the investment

t = the number of time periods in months that the deposit remains invested

Here’s an example using the future value formula:

FV = ($100 + $5) or $105

If you deposit $100 at the end of the first year at an interest rate of 5% and if the number of years is one year, you can read the formula as follows:

“The future value (FV) at the end of the first year equals the present value ($100) plus the value of the interest at the specified interest rate (5% of $100 or $5).”

How does future value work?

To determine the value of your investment at the end of two years, you must adjust your calculation to include an indicator representing the two periods:

FV = $100 (1 + 0.05)² = $110.25

Continuous periods mean that you continue to calculate for the number of payment periods that you need to determine.

Future value using a financial calculator

In fact, you can use this formula with any calculator that has a square function key. However, using a financial calculator is better because it has dedicated keys corresponding to each of the four variables you will use, speeding up the process and reducing the likelihood of error. Here are the keys you will press:

Press N and 2 (for a retention period of two years)

Press I/YR and 5 (for an interest rate of 5%)

Press PV and -105 (for the amount of money we are calculating interest on in the second year)

Note that the present value of the investment should be set as a negative number so that you can correctly calculate future positive cash flows. If you forget to add the negative sign, the future value will appear as a negative number.

Press PMT and PMT (no payments after the first one)

Press FV, which returns the answer of $110.25

Future value using a spreadsheet

Spreadsheets, such as Microsoft Excel, are perfectly suited for calculating time value of money problems. The function we use for the future value of an investment or a single amount in Excel is:

The rate is the interest rate, nper is the number of periods, pmt is the amount of the upfront payment (if any, and must be the same throughout the investment period), pv is the present value, and type is when the payment is due. The payment due value is either one (beginning of the month) or zero (end of the month).

To use the function in a worksheet, click on the cell where you want to enter the formula. Enter the formula below and press enter.

=FV(0.05,1,0,-100,0)

It should

You will receive a value of $105.

Future Value Limitations

Future value calculations are estimates of the investment’s value in the future. There are some situations where future value calculations may be inaccurate:

If interest rates are fluctuating rapidly, the future value may not provide an accurate answer as it is only sensitive to interest rate changes if they remain stable over the specified time period.

In an inflationary economic environment, the purchasing power of future cash flows decreases. In this case, future value calculations are only approximations. If currency values fluctuate, future value calculations may not accurately reflect the actual value of the investment.

Takeaway

The calculation of future value determines the rate of return on the investment, holding all else constant. Accumulation, which is another word for future value, occurs when interest is paid on interest.

There are certain economic conditions that undermine the strength of future value calculations.

Was this page helpful?

Thank you for your feedback!

Tell us why!

Sources:

Corporate Finance Institute. “Time Value of Money.” Accessed Sept. 29, 2020.

Financial-calculators. “Future Value Calculator.” Accessed September 24, 2020.

Source: https://www.thebalancemoney.com/how-to-calculate-the-future-value-of-an-investment-393391