Future value formulas help individuals determine what a certain amount of money will be worth over a certain time period. For example, investors often use these formulas to determine which investment out of several choices will bring the most financial return. Many different future value formulas exist, allowing individuals to use them for different applications. The most common types includes lump sum, variable payments over multiple years, and annuity future value calculations. Each has a specific use, with modifications possible in order to present the best answer possible from given inputs.
Lump sum future value formulas assume an individual is going to place a large amount of money into one interest-bearing investment. These investment types may be bonds, certificates of deposit, money market accounts, or similar items. In order to best compute the future value of a lump sum, the use of a financial calculator — whether physical or from an Internet website — is the best way to do so. The individual simply fills in information like the initial amount or lump sum, number of years for the investment, annual interest rate, and any additions or subtractions to the lump sum during the time period. The result is the future value of the lump sum based on the data plugged into the calculator.
Variable payment future value formulas are a bit complex. Data such as annual interest rate and length of the investment period are similar to the lump sum formula. With variable payments, however, the individual must define individual years in which the cash flows will go into the investment. A calculator with cash flow function or multiple years' input for the annual payments made into the investment is necessary. Once all the data is in place, the calculator returns a future value; the reason for this formula comes from different future value figures applied to the payments made each year into the investment.
An annuity future value formula is both similar and different to the variable payments future value formulas. Here, individuals must define if payments made into the investment are made at the beginning of the year or the end of the year. Obviously, payments made at the beginning of a year earn more interest than those payments made at year-end. Investors must be very careful to define the correct inputs when using future value formulas for annuities. Bad information put into the calculator can make an annuity look more attractive than it really is, creating a distorted investment selection.
