So let’s back up…what do we mean “in today’s money?” Let’s explain it with an example. Imagine you won a contest and the prize money is $5000. You can choose to get all the money now or to take it in installments over the next three years. Which would you choose?

You would probably take the whole amount now, right? Why? Because it seems better to have all the money now than to have to wait three years. You’ve just stumbled upon the financial concept of time value of money, which basically says money in the present is worth more than money in the future.

Time Value of Money
But isn’t $5000 still $5000 in 3 years? Not really, and here are two reasons…

Inflation – Has your grandma ever told you she used to go to the movies for a nickel? That’s because when she was young, movies were worth less and money was worth more. Why? Inflation. In simple terms, inflation means that over time, prices go up and things become more expensive, so it takes more money to buy the same product.

Investment – You can do something with money you have in your pocket now. You can invest it and make it grow. You can be reasonably sure that you will have more than $5,000 later, because even if you just put the money into your savings account, you will earn some interest. But if you wait to take the money over time, all you have at the end of three years is $5000. Right there, you can see money now is more valuable because of what you can do with it. You lose value while you are waiting.

Future Value
So, you’ve decided to take the $5000 now, but you want to know how much it will be worth in 3 years. You have decided to invest the whole amount and think you will get 5% interest per year.

When you put $5000 in the bank and earn 5% interest how much money do you have at the end of the first year? You start by figuring out what 5% of 5000 is, so 5000 multiplied by .05 is 250.

5000 x .05 = 250

Now you know you will earn $250 in interest during the first year. Add that to the amount you started with, $5000 and at the end of the first year you will have $5250. In two steps, you now know how much your $5000 will be worth at the end of year one.

You can shorten your work into one step. At the end of one year at 5% interest you will have 105% of the amount you started with. In other words, you still have 100% of your $5000, and at the end of the year you will have 5% more, so you’ll have 105% of what you started with. Look at this idea in a formula where 1.05 represents 105%.

5000 x 1.05 = 5250

See how you can cut your work down from two steps to one? You can see this idea in the formal equation for Future Value:

Future Value = initial amount x (1 + percentage rate)

What does each piece of the equation mean?

• Future value is how much today’s money will be worth in the future.


• The initial amount is the amount you are going to invest.


• 1 represents 100% of the initial investment


• Percentage rate is what you will earn on the investment.

You would write out our example as:

Future Value = 5000 x (1 +.05)

Now you know how much you have at the end of year one, but how about at the end of year three?

When year two starts 5250 is everything you have. It is now 100%. You are still going to keep your 100% and add 5% more, so you would multiply 5250 by 105% to learn that you will end year two with $5512.50. In other words:

5250 x 1.05 = 5512.50

At the start of year two, how much is 100% now? 5512.50, and again you expect to have 105% at the end of the year. $5512.50 multiplied by 105% is $5788.12.

5512.50 x 1.05 = 5788.12

So at the end of year three, the $5000 you started with is now worth $5788.12.

Doing the math three times isn’t too bad, but what if you want to know what your money will be worth in 10 years or 20 years? There is a more efficient way to figure out future value over several years. Think about what you did to get 5788.12. You really multiplied 5000 by 1.05, then by 1.05 again, then by 1.05 a third time.

5000 x (1 +.05) x (1+.05) x (1 +.05) = 5788.12

Try it on your own calculator. You can represent this idea another way:

5000 x (1 + .05)³

Now you have 1.05 to the third power or 1.05 x 1.05 x1.05. In this example 3 is the number of years in the future you want to know about. But you could use any number of years into the future.

Think back to the formal equation for future value, which you looked at earlier. Now add this new idea we’ve discussed about how many years into the future you want to calculate the future value. Here’s the formal equation:

Future Value = initial amount x (1 + percentage rate)^{number of years}

With this formula you can figure out how much something is worth for any number of years in the future.