Explaining Future Value: Formula, Uses And FAQs

You invest your money now with the hope that it will be worth more at a later date. But how do you know what that investment might be worth in the future? There’s no way to know for certain, but the future value formula can help you come up with a rough estimate.

Calculating future value can help you understand the value of your investments by showing you what an investment might be worth in the future. It’s a good idea to understand how future value works, how to calculate it and the pros and cons of doing so. 

What Is Future Value? 

An asset can take many forms, including stocks, bonds, investment properties, retirement and savings accounts. Calculating future value helps you see what your initial investment can add up to over time. 

Future value is a calculated estimate of what an asset will be worth in the future. The calculation is limited because it requires a stable growth rate, but it allows investors and financial planners to create a forecast and plan ahead.

Practical Uses For Future Value

Future value can technically be used to forecast stock market investment returns, but the formula works best for something with a stable growth rate. For example, you could calculate the future value of a savings account with a guaranteed rate of return.

Future value is often used to plan for a financial goal, like saving for a down payment on a house or planning for retirement. You can use future value to calculate what your initial investment needs to be and how much you need to save each month to meet your goal. 

Future Value Formula

There are two formulas for calculating future value and the one you’ll use depends on whether the asset relies on simple interest or compound interest.  

Calculating Future Value With Simple Interest

Simple interest is the amount of money paid based on your principal amount and doesn’t include compound interest. The following is the future value calculation for simple interest: 

Future Value (FV) = Interest Rate (R) x Principal Amount (P) x Number Of Years (T)

Let’s say you invested $1,000 into an investment account that earns a 7% annual rate and you want to find out how much you’ll earn in 2 years. Here’s how you’ll apply the FV formula:

FV = 0.07 x 1,000 x 2 = $140

This means you’ll earn $140, or $70 each year in simple interest.

Calculating Future Value With Compound Interest

Compound interest is any interest you earn based on your current balance in your account. In other words, any interest you earn is added to the principal amount and can earn additional interest.

As time passes by, as long as you don’t withdraw funds from your investment, the earned interest will get added to the principal, and the interest payments can grow more and more. Here is the formula for calculating future value with compound interest:

FV = P x (1 + [R/N])^NT

Where:

• P = principal balance
• R = interest rate
• N = number of times interest is compounded
• T = number of years the money compounds

For example, you invest $1,000 in an account that earns 7% in interest that’s compounded monthly, or 12 times per year. Let’s take a look at how much you’ll earn in 2 years:

FV = 1,000 x (1 + [0.07 / 12])^(12 x 2)  = $1,149.81

This means you’ll earn around $1,149.81 after 2 years.

As you can see from the examples above, there’s a significant difference in earning simple interest versus compound interest. It’s safe to assume that the longer you keep funds in an account that earns compound interest, the more you’ll earn, resulting in significant earnings over the long term.

Pros And Cons Of Using Future Value

Calculating future value can be a useful tool to help you understand the actual value of your investments. But there are some pros and cons to consider first. 

Pros

• Future planning: Having an estimate of what an asset will be worth can help you plan for your future. For example, future value can be useful for retirement planning or working toward any financial goal. 
• Streamlined formula: The variables in the formula provide a hypothetical estimate for a variety of potential assets.
• Comparison: Calculating future value allows you to compare different investment options and pick the best option. 

Cons

• One interest rate: The future value formula doesn’t always match reality and while it’s technically possible to calculate future value with multiple interest rates, it becomes much more complicated. 
• Hypothetical future values: Due to the way the market fluctuates for many investments, the estimates you receive when calculating future value may not pan out. For example, if the rate of return is lower than you initially calculated, this will affect your returns.
• Incomplete picture: Relying solely on future value to choose between investments can lead to one investment looking more favorable even if that isn’t true when accounting for factors like the risk level of various investments.

Future Value FAQs

The concept of future value can seem confusing at first, but it’s pretty straightforward once you understand how it works. Here are the answers to some additional questions you may have about future value. 

What is the future value of $1,000 after 5 years at 8% per year?

Here’s the formula you’ll use to calculate the future value of your investment:

FV = 0.08 x 1,000 x 5 = 400

Assuming none of the variables change, this investment will earn you $400 over 5 years. 

What is the future value formula used for?

The future value formula is used to calculate the value of an investment at a future date. Investors use future value when assessing potential investments, and it’s a useful tool in financial planning. 

How do I calculate the present value?

The present value is the current value of a future sum of money or investment. You’ll calculate the present value for a compound interest investment with the following equation: 

PV = FV / (1+R)^N

When: 

PV = present value

FV = future value

R = rate of return

N = number of times the interest will compound

The Bottom Line

Using a future value formula is a useful way to evaluate investments and come up with a financial plan. It does have its limitations, so future value shouldn’t be the only criteria you use when choosing an investment.

The right financial tools can make it easier for you to manage your money and plan for your financial goals. If you’re looking for additional help assessing your finances, you’ll want to check out the Rocket Money^℠ app.