Future Value (FV): Calculation & Investment Growth Explained

When investing your money, you probably want to know what your investment will be worth in the future. That’s why calculating future value is so beneficial – it helps investors estimate what an investment may be worth, either via simple or compound interest. 

What Is Future Value?

Future value (FV) calculates how much an initial savings amount will be worth based on the amount invested, the amount of regular contributions, and the length of time it is held in an interest bearing or appreciating investment vehicle. Future value demonstrates that the benefits of compounding interest and beginning a savings plan as soon as possible can lead to amassing a significant amount of wealth.

Understanding Future Value

The key to understanding future value is learning how interest works. Essentially, it’s money you earn from funds you keep in an account such as a savings or certificate of deposit (CD) account, or interest-bearing investment, like a bond or bond fund account.

Future Value Of An Account Earning Simple Interest

Simple interest is an amount of money paid based on your principal amount. In other words, you won’t receive interest on interest that’s already accrued in your account.

The following is the future value formula for calculating simple interest:

FV = Interest Rate x Principal Amount x Number Of Years

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:

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

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

Future Value Of An Account Earning Compound Interest

Compound interest differs from simple interest in that any interest you earn is based on your current balance in your account. In other words, any interest you earn is added to the principal amount. When it’s time to calculate how much interest you’ll earn next, it’ll be based on a larger principal, and your interest payment will be larger.

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 two years:

FV = 1000 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 both 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.

Future Value Rewards Risk Takers

At its core, an interest rate reflects the riskiness of the transaction. All loans tend to be charged at a markup to a benchmark rate and depend on a number of other factors. 

Interest Charged

The interest rate you’re charged (or the markup) depends on the type of loan and the borrower’s credit score and history.

For instance, mortgages, which are generally considered the least risky type of consumer loans, charge higher interest rates to borrowers with a poor credit rating. That’s because lenders believe they’re taking a risk because the likelihood of that borrower defaulting on a loan is high. Still, mortgage rates are generally lower than other types of loans since it’s considered a secured loan – a loan backed by collateral

Credit cards, on the other hand, are generally the riskiest type of consumer loan and have high rates — often in the double digits — because they’re unsecured.

Interest Offered

All investments compete in a marketplace for our investment dollars. You have the opportunity to invest at various financial institutions and in different products such as stock, bonds, real estate, the secondary mortgage market and physical commodities.

Generally, the higher the interest rate, the riskier the investment tends to be. Depending on the type of account, you have the potential to earn more, but there’s also the possibility of losing money. Those with a longer-term investment plan might be comfortable assuming more risk, while those with shorter term goals might not.

Is Future Value Only Used With Interest-Bearing Accounts?

Calculating future value for accounts invested in stocks, mutual funds, or ETFs is less straightforward than it is for interest-bearing accounts like ones offered at banks. Investors in the stock market earn money through appreciation of a stock’s value and dividends paid to shareholders. Keep in mind it’s impossible to predict from year to year how a stock will fare or whether dividends will be paid. However, this volatility – investments going up and down in value more often – tends to have higher returns overall.

How Is Future Value Calculated For Non-Interest-Bearing Accounts?

Accounts that don’t normally incur interest are called non-interest-bearing notes. This is a bond with no stated interest rate at its face value. Rather, it’s implied.

This is how it works: the note is used for an amount less than the face value, and as it matures, the entire face value is paid back, earning the investor a profit.

Let’s say you have a non-interest-bearing note with a face value of $10,000 but the company that borrows the money only receives $7,000. It agrees to pay the full $10,000 over the next 5 years. This means you’ll receive on average $600 in interest per year.

Summary: Start Early And Let Your Money Work For You

Looking at the future value of your investments is important to determine what you want to invest in, as well as the potential wealth you’ll accumulate over the long term. Both simple and compound interest accounts offer the chance to earn decent returns, though compound interest will earn you more over your lifetime. As with all financial decisions, consult a financial advisor to see what works best for you.

If you’re interested in other aspects of your personal finances, check out the Learning Center on Rocket HQ^SM to get you started on your path to financial wellness.