Future Value

Future value is a measurement of the value of an investment at a specific point in the future; it assumes a predictable rate of return on the investment, such as a consistent interest rate. It does not incorporate the fluctuation in value created by factors like inflation, and thus is not as accurate a measure of investment return as indicators which include an estimate of the time value of money. Basically, the future value is determined by multiplying the present value by a rate of interest or growth over time; this rate is known as the accumulation rate.

Future value formula

For simple interest, the future value formula of an investment is derived by multiplying the present value by the sum of one plus the annual interest rate multiplied by the number of years, as in:

• Future value = Present value * (1 + (annual interest rate * years))

Compound interest rates are more complex, and typically require the use of a future value calculator or computer program in order to derive the figures. Essentially, future value on investments that include compounded interest are calculated by multiplying the present value by the sum of the interest rate plus one to the exponential power of the number of years, as in:

• Future value = Present value * (1 + annual interest rate)number of years

Thus, we can see that compound interest investments increase at an exponential rate, making them far more desirable for investors than simple interest transactions. Most future value calculations take into account the compounding of interest which adds to the future value money accrues over time. For variable rate interest calculations, actuaries normally use the risk-free interest rate; this is the lowest guaranteed rate for the investment, and is the most conservative method of calculation.

The process of calculating future value from a known present value is referred to as capitalization; it estimates the value of an investment at a present date, allowing analysts and investors to determine the profitability and advisability of a specific financial transaction. For instance, if a high-risk investment and a low-risk interest-bearing account both share the same future value on initial investment, it’s obviously better to invest money in the lower-risk alternative. The same criteria apply to other investments, including annuities, bonds, and preferred stocks.

Future value annuity calculations

An annuity is a series of payments made over time; fixed annuities are made in equal payments and generally are paid either at the beginning or end of the payment interval. Because an annuity has no set present value, it cannot be calculated using a simple or compound interest future value calculator. Future value annuity calculations often involve the compounding of interest multiple times during the same year; this results in extremely complex formulas that vary from annuity to annuity, and cannot be reduced to a single method of calculation.
Tim Ord
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