By James Bell
Future Value calculations are helpful when you want to know the future value of an investment made today. This formula takes into consideration the compounding nature of interest described in this article. You may notice some similarities between the articles.
Time is literally Money. Future value is important when considering alternatives and making decisions.
Rate of Return
Number of Years, or Periods
This is what the value is of the investment at the beginning. An example is the first deposit in a savings account or 401k. You can use this formula for a basic forecast of what your deposit will be after 5, 10, or even 20 years! Take into consideration the opportunity cost. If you invest here, you are not able to invest this same money elsewhere. As with any investment, understand what are your potential losses. If a deal seems to be too good to be true, it probably is.
The rate of return is the return that you get in return for your risk and opportunity cost. This can be very intuitive if you think about it. Would you rather have 1 dollar today, or a year from now? Is the person who borrows the dollar going to be able to pay you back? If you were to accept a dollar a year from now, what is a reasonable return you want to get paid for your risk? These basic questions help us understand that interest or return is a major factor of why we invest in the first place.
n is commonly used for the number of years in both finance and statistics. While our example shows years, if you compound monthly, for example, then you can use the same formula. Just be careful about keeping your periods and your rate consistent. You may need to adjust an annual rate down to a monthly rate when compounding monthly for example.
This is an important building block of understanding how to value investments and the time value of money. This is the value that we can expect when everything remains constant.
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