Financial calculators can help determine the future value of a lump sum, but the interest rate is crucial. For long-term estimates, use multiple interest rates for each five-year period. It’s important to know if the interest is simple or compound and how often it is compounded. Be careful when entering the interest rate in the correct format.
Determining the future value of a lump sum can be helpful in managing finances, planning for retirement, or deciding which investment vehicle to choose. Financial formulas and calculations are complicated, so the easiest method is to use one of the financial calculators that can be found on personal finance websites. Inputs include: the interest rate, the number of years, the lump sum amount, and whether the interest is compounded. A search for “financial calculator” will return many results to select the most suitable one.
The interest rate is the most important and most problematic factor in determining the future value of a lump sum. Financial calculators are based on the assumption of a fixed interest rate, which makes them more accurate for shorter periods of time. If possible, find a calculator that allows for multiple interest rates.
Interest rates don’t make huge jumps from year to year in most countries, but over the course of 10 or 15 years, the rate could change dramatically. Therefore, for long-term estimates of the future value of a lump sum, it might be more accurate to calculate the value using a series of five-year estimates with different interest rates for each five-year period. To do this, enter the current lump sum, the interest rate estimate for the first five years, and “5” for the number of years. Using the result of this as the principal, enter the interest rate estimate for the second five-year period, and use that result as the starting value for another five-year period.
It is necessary to know if the interest is simple or compound and, if it is compound, how many times a year it is compounded. Simple interest is paid once a year only on the original principal amount, and compound interest means that the deposit earns interest on the interest as well as the principal. If interest is paid once a year, it is compounded annually; compounding monthly means that interest is paid each month into the account, and the future value of a lump sum will grow even faster.
Be careful when entering the interest rate into any calculator. Some ask for the annual rate as a percentage, but others may ask for a decimal. Five percent would be “5” for the first, but “0.05” for the second. If the future value of a lump sum seems unbelievably high or low, verify that the interest rate has been entered in the correct format.
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