Future Value

Definition

Future value refers to the amount of money an investment will grow to over a period of time at a given interest rate. This concept is essential for understanding how savings and investments can increase in value due to interest, and it plays a significant role in making financial decisions. Future value helps individuals plan for financial goals by estimating how much money they will have in the future based on current investments, whether it's through simple interest, compound interest, or savings methods.

5 Must Know Facts For Your Next Test

1. Future value can be calculated using the formula: $$FV = PV(1 + r)^n$$, where PV is the present value, r is the interest rate per period, and n is the number of periods.
2. With simple interest, future value grows linearly because it is calculated only on the initial principal amount throughout the investment period.
3. In contrast, compound interest allows future value to grow exponentially as interest is calculated on both the principal and previously accumulated interest.
4. Investing early can significantly increase future value due to the effects of compounding, emphasizing the importance of starting savings as soon as possible.
5. Understanding future value helps individuals evaluate different financial products and make informed decisions about saving and investing their money.

Review Questions

• How does future value change when using simple interest compared to compound interest?
  • Future value using simple interest grows at a constant rate based solely on the initial principal amount. In contrast, when compound interest is used, future value increases more rapidly because it includes earnings from previously accumulated interest. This difference illustrates why compound interest is often considered more beneficial for long-term investments.
• Discuss how understanding future value can impact an individual's savings strategy over time.
  • Understanding future value allows individuals to assess how their savings will grow over time with different interest rates and investment periods. This knowledge can influence their choices about which savings methods to use, such as opting for accounts with higher compound interest rates. A solid grasp of future value helps individuals set realistic financial goals and make informed decisions about when and how much to save.
• Evaluate the role of future value in financial planning and investment decision-making for individuals aiming for specific goals.
  • Future value plays a crucial role in financial planning by enabling individuals to project how much their current investments will be worth at a future date. When aiming for specific goals like buying a house or funding education, understanding future value allows people to calculate how much they need to save today to reach those targets. Evaluating different scenarios based on varying interest rates and timeframes empowers individuals to make strategic investment decisions that align with their financial aspirations.

Related terms

Present Value: Present value is the current worth of a sum of money that is to be received or paid in the future, discounted at a specific interest rate.

Interest Rate: The interest rate is the percentage at which money earns interest over a specific period, affecting both simple and compound interest calculations.

Savings Account: A savings account is a deposit account held at a financial institution that earns interest on the balance, allowing individuals to save money while earning a return.