Definition: Future value (FV) is the amount to which a current investment will grow over time when placed in an account that pays compound interest. In other words, it’s the value of a dollar at some point in the future adjusted for interest.
What Does Future Value Mean?
What is the definition of future value? FV is one of the most important concepts in finance, and it is based on the time value of money. Investors need to know what the FV of their investment will be after a certain period of time, calculated based on an assumed growth rate.
For instance, a $1,000 investment that pays a fixed interest rate of 5% will be $2,654 after 20 years, all things being equal. Therefore, the FV uses a single upfront investment and a constant rate of growth during the time horizon of the investment. On the downside, the FV is not adjusted for high inflation or changes in the interest rates, which are factors with a negative impact on any investment.
Let’s look at an example.
Example
Mary has $8,500 in a checking account, and she earns an annual interest rate of 2.2%. Using the future value formula, Mary’s account after 15 years will be equal to:
FV = PV x (1 + r) ^n = $8,500 x (1+2.2%) ^15 = $11,781.
Also, Mary has $20,000 in another account that pays an annual interest rate of 11% compounded quarterly. Since Jan 1, 2016, the terms of the agreement have changed, and the compound interest is attributed twice a month. Mary wants to calculate the total value of her account on Dec 31, 2016.
Mary’s account from Jan 1 to Dec 2015 was:
- PV: $20,000
- Compounding period (n) = 4
- Annual interest rate (r) = 11% => Quarterly interest rate = 2.75%
FV = FV = PV x (1 + r) ^n = $20,000 x (1+2.75%)^4 = $22,292
Mary’s account from Jan 1 to Dec 2016 was:
- PV: $22,292
- Compounding period (n) = 2 x 12 = 24
- Annual interest rate (r) = 11% => monthly interest rate = 0.46%
FV = FV = PV x (1 + r) ^n = $22,292 x (1+0.46%)^24 = $24,878
Summary Definition
Define Future Value of Money: FV means an amount of money in the future discounted by an interest rate to equate the buying power of the future dollar with the present dollar.
