The Present and Future Value of Money

by Investing School on February 18, 2009

This is a guest post from Sam from Personal Finance Ology, a blog with intricate tips, guides and knowledge on getting your finances in order.

Knowing the present and future value of your money is one of the foundations of money management and investing. This knowledge will help us choose between different types of savings accounts that are available, deciding whether or not to keep money in the bank or to invest it and the information can also help you in deciding which investments will make you more money.

In the times of economic uncertainty, it is important that you do all you can to increase your money rather than holding on to it only to find out it won’t be worth as much in the future as it is worth now. There is a common saying amongst financial experts that will hold it’s presence throughout this article and should constantly serve as a reminder about the value of money and how fast it can change.

A dollar today is worth more than a dollar tomorrow.

This one saying can serve as a guiding point for anyone scared to invest because they feel the money they have is safer in their saving accounts. It can also guide the investor who quickly jumps at the excitement of the financial providers sales pitch of a great investment. Whether it’s an investment or an option of savings accounts that you are deciding on, it is always a smart idea to take a close look at the numbers rather than relying on your instinct of the sales pitch.

Future Value

Here’s an example. Let’s say someone came to you and offered you either $15,000 today or $16,000 in three years. The thought of $15,000 right now sounds great for some and waiting the three years and get a larger amount would make sense to others. However, the truth is in the numbers.

For the sake of this example let’s assume we get a three-year CD that pays 6 percent interest. This will give us a return on our investment worth $2,700. This means if we took the $15,000 now in three years we would get $17,700 from investing it, which is more than waiting three years for $16,000.

A way to manually calculate the amount of money you will make from an investment is by using the formula below:

Future value = original sum * (1 + interest rate)

Note: You can also use the calculators that will compute future values of lump sums (just google for it). A lot of spreadsheet programs, including Microsoft Excel have them as well.

Now let’s dissect the saying “a dollar today is worth more than a dollar tomorrow”. It can be misunderstood to mean that the dollar value will decrease drastically tomorrow and lessen the amount you have in the bank. For this context, the saying is indicating that the dollar you have today will be worth more tomorrow if you plan accordingly.  If you don’t, it will be worth less tomorrow than what it could have been worth had you put it to work for you. Simply put, every dollar has the potential to double or triple in value with the addition of interest.

Present Value

Another way to make the choice of being paid now or paid later or how much to invest would be to calculate the present value of the future amount. Let’s say you wanted a certain account to be $10,000 in three years. In order to implement a plan to get there you would have to determine the present value of $10,000 in three years. To do this you would use a present value calculator and plug in the numbers. What you will find is that you would have to invest approximately $8,396 with an interest of 6 percent compounded annually in order to make $10,000 in three years. With this information you can now implement a plan to invest the amount needed with the specified terms to ensure that you will make the desired amount in the time frame you would like.

Here’s the Deal on Present and Future Value

The future value of money uses the interest money can earn and what that will be worth to you today while the present value of money looks at the amount of money you would like to have in the future and how much you would have to invest today to make that amount in the future.

Taking the time to determine the present value of future money or the future value of present money can prove to be beneficial.  It will increase your finances and allow you to allocate your funds accordingly so that you are getting the most for your money rather than letting in sit in a sedentary account where it’s value remains the same.

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