The future value of an annuity is the value of a group of recurring payments at a certain date in the future, assuming a certain type of return, or discount rate. Due to the time value of money, money received or paid today is worth more than the same amount of money in the future. Let's see how we can apply the future value of an annuity to our investment portfolio.
What is the future value of an annuity
The future value of an annuity is the value of a group of recurring payments at a certain date in the future, assuming a certain type of return, or discount rate. The higher the discount rate, the greater the future value of the annuity. As long as all the variables surrounding the annuity are known, such as the payment amount, the expected rate, and the number of periods, it is possible to calculate the future value of the annuity.
What is the future value of an annuity for?
Due to the time value of money, money received or paid today is worth more than the same amount of money in the future. This is because money can be invested and grow over time. By the same logic, a single payment of $5.000 today is worth more than a series of five annuity payments of $1.000 spread over five years. Annuity payments are usually made at the end of a period. However, an annuity due is a payment made at the beginning of a period. Although it may not seem like much of a distinction, there can be considerable differences between the two when considering what interest is earned.
Formula for calculating the future value of an annuity
The formula for the future value of an ordinary annuity is as follows. (An ordinary annuity pays interest at the end of a given period, and not at the beginning, as is the case with an annuity due.)
Formula for calculating the future value of an annuity.
Example of using the future value of an annuity
Suppose someone decides to invest €125.000 per year for the next five years with an annuity that they expect to compound at 8% per year. In this example, the payment series is a regular annuity in which payments are made at the end of each period. The expected future value of this series of payments using the above formula is as follows:
