Value functions

1. Value functions

Next, you are going to learn about how to use the future value function and estimate effective interest rates to grow your investments.

2. Understanding compounding

The simple interest rate is the amount of money you might expect to make on your investment, and you can multiply that rate by the investment and time invested. Compound interest applies that simple interest to your investment plus any previously made interest, therefore increasing your investment by making interest on interest. Compounding frequency is the number of times the interest earned is added back to your original investment.

3. Model of compounding frequency

Here is an example Sheets model of compounding interest. The nominal interest rate is the simple interest rate, as advertised by the investment portfolio since it doesn't account for any compounding interest that might be accumulating. Present value includes the initial investment or deposit, and the length of investment is the number of years you plan to leave in your money. The chart expands on the compounding frequency, showing the effects of compounding rate. Annual rates only add interest once a year, while weekly rates add interest 52 times a year. Let's look at how the other values are calculated.

4. Effective interest rate

The effective percent rate tells you the actual return on your investment given the compounding periods, which allows you to see how much more you might gain with a higher compounding frequency. The formula is one plus the nominal rate divided by the compounding frequency, then taken to the power of the compounding frequency minus one. The power function is typed by using a caret or shift plus 6 on a US keyboard. To calculate that value in Sheets, you will use an absolute reference to the nominal interest rate with the dollar signs to assure that value doesn't change. For compound frequency, you will use the number of compounding periods per year in column B.

5. Future value function definition

For future value, or how much money you'll make by the end of the investment, you can use the fv() function. This take four arguments, rate - the interest rate for a compounding period, number of payments - the number of payment periods, payment amount - the payment made in each period, and present value for present value of the investment, entered as a negative number.

6. Future value function on Sheets

For rate, we will enter the new effective rate we calculated. Number of payments will be an absolute reference to the length of our investment, which is stored in B5. Payment amount could include any extra money we would want to put down or payment on a loan, but here we will assume you do not invest any other money and leave it zero. Last, present value is current investment amount, and a negative number is used when estimating for growing investments. A positive number can be used when estimating the future value of a loan you are making payments on.

7. Future value function output

When taken all together, we can tell that we should have made at least 300 dollars from our initial 500 deposit, and that compounding interest increases that rate of growth, but only by about 10 dollars.

8. Estimate the years

Now you can use this worksheet to estimate at different interest rates, investments, and investment lengths. How much time would it take to make 1000 dollars? By increasing the length of investment, I can tell it's about 15 years at the annual compounding interest rate.

9. Try it yourself!

Now it's your turn to estimate investment rates.

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