Future value

Future value answers a simple question: if I invest this much today, how much will I have later? It needs three inputs: the amount invested today (PV), the rate of return per period (r) and the number of periods (n). Because each period's return is added to the base for the next one, money grows faster the longer it stays invested. That is compounding.

Compounding more often

If returns are added more than once a year, divide the annual rate by the number of compounding periods a year (m) and multiply the years by the same number:

FV = PV × (1 + r/m)^(m × n)

Monthly compounding gives a slightly higher result than annual compounding at the same stated rate.

Future value of regular investments

A SIP adds money every month, so each instalment compounds for a different length of time. For a monthly investment P at a monthly rate i over n months, with each instalment made at the start of the month:

FV = P × [((1 + i)^n - 1) / i] × (1 + i)

The SIP calculator and the future value calculator do this arithmetic for you.

Real versus nominal future value

A future rupee buys less than a rupee today. To see what a future value is worth in today's money, divide it by (1 + inflation)^n. A goal that looks comfortable in nominal terms can look very different in real terms.

A quick check: the rule of 72

Divide 72 by the annual return to estimate how many years money takes to double. At 12 percent it doubles in about six years; at 8 percent, in about nine.

Common mistakes

• Using an annual rate in a monthly formula without converting it.
• Treating an assumed return as a promise. Equity returns vary from year to year, so test a range of rates.
• Ignoring tax, fees and inflation, which all reduce what you actually keep.

Questions investors ask

What is the difference between future value and present value? They are the same calculation run in opposite directions. Future value grows today's money forward; present value discounts future money back to today.

How do I calculate future value in Excel? Use =FV(rate, nper, pmt, pv, type). Enter the amount invested as a negative number, because it is money going out, and the result comes back positive.