Definition
Future value is the amount that a sum of money held today will grow to at a specified future date, given an assumed rate of return over the intervening period.
Why it matters
Retirement income analysis often begins with a savings balance today and asks what it can support in the future; the first mechanical step is projecting the balance forward to a target date. Future value names this projection directly. Without it, no comparison between what an individual has today and what a future income arrangement will require can be constructed on a consistent basis.
How it works
Future value is computed by compounding a present amount forward at an assumed rate of return. A $10,000 balance held for ten years at a 5 percent annual return grows to about $16,290; the same balance held for twenty years at the same rate grows to about $26,530. Longer periods and higher rates produce larger future values, and the growth is multiplicative rather than additive because each period's return is earned on the balance including all prior returns. For a series of contributions made at different points in time, the future value at a target date is the sum of each contribution grown forward at the assumed rate to that date. Real-world projections often produce a range of future values by varying the assumed rate; the range is a starting point for how much dispersion the individual should expect in the actual outcome.
In practice
For an individual approaching retirement, future value is the tool that translates a current savings balance into an expected balance at a chosen commencement date. This is the input to any lifetime income analysis that begins from a target commencement rather than immediate income. Individuals evaluating a deferred income arrangement, for example, need both the future value of savings at the commencement date and the future value of premiums paid between now and then. A professional working with the individual will typically vary the assumed return to show a range of projected balances rather than a single figure, because the actual return over any specific interval is not known in advance.
Related terms
- Present value
- Compound annual growth rate
- Discount rate
- Deferral multiplier
- Real versus nominal discount rate
- Accumulation phase
- Investment yield