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.

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

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

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.

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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