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Future value refers to the value of money at a future date.
Suppose you won a lottery of £10,000, and you were given two options to take that money. Option 1 is to take the money today, and option 2 is to collect the money after 5 years. Not surprisingly, you will choose to collect the money today. If you collect the money today, you can invest it and earn interest on it, and you will get a higher amount after 5 years.
Example 1: At an annual interest rate of 5%, the future value of £10,000 after 5 years will be £12,782.82. Whereas if you choose to take the money after 5 years, the future value of the amount will be £10,000 after 5 years, because the money has not grown.
Future value is an important concept in the world of investments. Anybody who is making regular investments in a particular instrument would like to know the value of the investment after a specific period.
Example 2: You are investing £5,000 in bonds every year for the next 10 years. Additionally, you are investing £500 every year for 10 years. Assuming an interest rate of 4%, the future value of your investment after 10 years will be £13,404.27.
Future value is also useful for those who want to make a purchase or an investment at a future date.
Example 3: You want to buy a property in London after 5 years. Taking the current property prices and assume a standard rate of increase (based on historic growth), you can calculate the approximate future value of the property after 5 years. This way you can plan your savings in such a way that you have the target amount after 5 years.
In 2015, the average price of a house in London is £451,194. Assuming property prices are expected to grow at 6%, the future value of this house after 5 years is £603,800. In order to buy this home, you need to have adequate savings to match the price after 5 years and not the present price. You will require at least 5% of the property amount as deposit before you apply for a mortgage. So, you need to have savings of at least £30,190 for the deposit.
We look at the values that are essential for calculating future value.
Present value: This is the value of money at the present time. In example 1, the present value is £10,000. In example 3, the present value is £451,194.
Annual interest rate: This metric can influence the future value in a big way. A higher annual interest rate will mean a higher future value.
Payment amount: This amount is relevant when you are making payments at regular intervals, and you want to know the value of these payments at a future date. Like in example 2, you are making payments of £500 every year, so this will be the payment amount.
Number of payments (years/months): The future value is influenced by the number of payments made and their frequency. The higher the number of payments, the greater will be the future value.
Payment frequency: This refers to the frequency of payments, which can be monthly, quarterly, 6 monthly or yearly. A higher payment frequency will result in a higher future value.
Future value is a very important concept in the world of business and finance. To calculate the future value, you can try out our future value calculator.
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