Sunday, January 9, 2011

Future Value of Money

Part of my Engineering degree required taking a class called Engineering Economy. Most of the class was filled with calculating annuities and savings and calculating whether a present value of money was worth spending or would it be better to save.

FUTURE VALUE FORMULA
On this website there's the Free calculator for you. This calculator requires the amount you save a over a period of time at a specific interest rate. How much would you have at the end of 30 years if you saved $100 a month at a return of 10%? According to the calculator you would have $197,393. That's only saving $100 a month.

What if you put a lump sum in an index fund that returns 10% interest each year for 30 years?

The Compounding Formula for Future Value would be this:

FV = PV (1 + i)^t

Where:
FV = Future Value
PV = Present Value
i = interest rate/time
t = time

EXAMPLE 1
Let's say we spent $25,000 renovating our house. What is the actual cost of the renovations in terms of future value. According to this formula it would be:

FV = $25000 (1 + .10)^30 = $25000 * 17.45 = $436,235

By spending $25000 today you forgo a future savings of $436k in 30 years.

You can use this formula for pretty much anything.

EXAMPLE 2
A friend is getting married soon, if you do a quick google search, the average wedding for most couples is $20k.

In 30 years, that $20k is actually worth $350k.

By choosing a slightly cheaper venue and spending half of that $20k, you actually save $175k in 30 years.

And if you were like us, and go even cheaper, spending a quarter of that $20k would be saving you $262k. Well, that is if you actually invested the rest of your money. We ended up paying off school loans, and later spending $25k on home renovations.

Oh well. You win some you lose some.

What can a budget do for you?

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