The future value for your savings can be calculated using either a simple interest rate, or compound interest.

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## What does ‘future value’ mean?

Whether it is an investment you’ve made or money you’ve stashed away in a savings account, you’ll want to know “how much will this be worth in 5 years or 10 years time?”

Although it is important to focus on the here and now, when it comes to finances, making sure you’re investing your money in the right places is vital for the future health of your wallet.

When we calculate ‘future value,’ what we are referring to is how much will this asset be worth in the future based on an assumed rate of growth.

For example, if we deposit \$250/month into a savings account and gain 1.5% interest each year, how much will it be worth in 10 years time? Working this out would be the future value of the savings account based on the assumption that the interest rate stays at 1.5% each year.

From an investment perspective, they will need to assess whether the money they invest in a business will see a healthy return in the future. Therefore, if they invest \$10,000 in a business, they would need to work out how much this could potentially be worth in the future.

## What can affect future value?

Although future value is an estimation based on reasonably reliable indicators, there can be external economic factors which may affect the future value of your asset, some which you cannot predict or control.

Inflation is a factor which will always exist, and is ever changing. An increase in inflation means the cost of a basket of goods is now more expensive, for example a shop that used to be \$50, now costs \$51. This means your business expenses will go up, and unless you increase the price of your goods, your profit will decline.

Interest rates can also affect your future value, especially if your asset is a savings account. If we refer back to early 2020 the majority of banks had a savings interest rate of above 1.5%. However, after the COVID-19 pandemic, this was cut to below 0.5%, some as low as 0.01%. For example, if you had \$20,000 in a savings account earning you 1.5% each year, you’d earn \$25/month. However, if it drops to 0.01% each year, you’d earn \$1.67/month. That’s 93% loss in the future value of your asset.

We also have consumer trends, financial recessions, product lifecycle, new or competing technology etc which all can rapidly change the future value of your asset, either by eroding it’s value, or by making it redundant. For example, someone who has a business making tape recorders, then the CD player comes along.

## How to calculate future value

Calculating the future value of an asset can be tricky because it depends on the type of asset, and also if the rate of growth is consistent each year. This can be easier to determine for savings accounts, but not for investors.

The two most straightforward calculations of future value are: simple and compound interest rates.

### Simple interest rates

If you have a set amount of money upfront dedicated towards an investment that assumes a constant rate of growth, by using a simple interest rate formula you calculate the interest earned only on the initial investment.

For example, you place \$10,000 into a savings account that earns 1% interest each year, and plan to leave it there for 5 years. Firstly we take the interest rate and convert it into a percentage and multiply it by the number of years it’ll remain. We then add 1 to this figure and multiply it by the initial investment.

Therefore, 0.01 multiplied by 5 years equals 0.05, adding 1 we get 1.05. Multiply this by \$10,000 we get \$10,500.

`(1 + (rate of interest * time) ) * investment = future value`

(1 + (0.01 * 5) ) * \$10,000 = \$10,500

### Compound interest rates

Unlike simple interest rates which calculate the future value based on the initial investment, compound interest calculates the rates based on the balance at the end of each period, such as each month, or each year.

If we take the same example of \$10,000 which will be in a savings account for 5 years with an interest rate of 1% each year, this is how we could calculate its future value.

Firstly, we would take the interest rate and convert it into a percentage again and add 1 to this figure. Now you would times it by itself according to the number of periods, in our example it’s 5 years. The figure is then multiplied by the initial investment.

Therefore, 0.01 add 1 equals 1.01, then to the power of 5 (1.01 * 1.01 * 1.01 * 1.01 * 1.01) which equals 1.051 (rounded to 3 decimal places). Multiply this by \$10,000 we get \$10,510.

`(1 + rate of interest) power of time * investment = future value`

(1 + 0.01)⁵ * \$10,000 = \$10,510

Using compound interest rates is beneficial for those who regularly top up their investment, such as those who deposit recurring amounts into a savings account.