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What is Future Value (FV)?
In simple words, the current value of an asset at a future date based on an assumed rate of interest is known as the Future Value (FV). It is of prime importance to the investors and financial planners as the future value is used to maintain businesses and handle investments that what proportion of it made today will be worth in the future. It also permits investors to make sound investments that support their anticipated needs, helps them make a sensible decision, and gives a clear insight into the market. However, external economic factors like inflation can adversely affect the future value of an asset by scraping away it’s worth, gradually affecting the long term investment options.
The calculation of future value formula integrates the asset’s (or the investment’s) present value, the interest rate, and the number of years taken into account.
The equation used in most businesses, to keep track of their investments, is:
FV = PV (1 + r) ^n
(Where, FV= future/final value, PV= Present value (the initial value of the investment), r= interest rate (given on an annual basis), n= the number of periods ( in this case years) money invested for)
This formula is applied to investments in which the compounding period is the same as the period for which the interest rate is calculated (e.g., a yearly compounding and an annual growth rate). Occasionally, however, the interest is compounded on a more periodic basis (quarterly or monthly). In such cases to get the future value of the investment, a more complex formula is used:
FV = PV (1 + r/k) ^(nk)
(Where k is the compounding frequency i.e the number of times interest is compounded per year)
If the values of this equation are not known, use a present value calculator to assess the investment’s value. Normally, the period is one year as interest rates are often calculated annually.
Key Takeaways
- Future value (FV) is the value of a current asset which changes in the future supported by an assumed rate of growth.
- Investors are ready to assume that the Future Value (FV) calculation is an appropriate means of profit-making strategy.
- Due to the market’s rapid volatility restraining, the Final Value (FV) of a market investment is often challenging.
How to calculate the Future Value (FV)?
There are two ways to calculate The Final Value (FV) of an asset that is, FV using simple interest and FV using compound interest.
In the case of simple interest, let’s suppose the initial investment of Mr. Rashid is $1000. The interest rate is 4% and it is compounded yearly. What will be the future value of this investment after three years?
Based on the future value formula present in the preceding section,
FV = $1,000 * (1 + 0,04) ^ 3 = $1,000 * 1,1248 = $1,124.8
After three years the future value of the investment made by Mr. Rashid will be $1,124.8.
If the interest rate is compounded monthly, the future value of $1000 investment will be (as per the formula mentioned above):
FV = $1,000 * (1 + 0,04 / 12) ^ (3 * 12) = $1,000 * 1,1273= $1,127.3
This time the future value of the investment made will be $1,127.3, which shows that this value is higher by $2.44. It is clear that if the interest rate is compounded frequently, the future value of the investment is likely to be more profitable than annual compounding.