Investors make decisions about what to do with their money based on the probability of being able to generate value. This is true of large, risky investments as well as simple, low-risk investments that rely on the future value of money to provide a return on investment. Each type of investment, including those that rely on future value principles, have drawbacks as well as upsides.
Future Value Concept
The concept of future value, or time value of money, is a core economic concept. It states that the presence of investment options means that money has the ability to generate more money, thereby increasing its own value. A future value investment is an investment that allows money to earn interest, presumably in a bank account, for a given period of time, resulting in a future value for the investor that is higher than the current value.
One of the benefits of a future value investment is the high degree of security that investors enjoy. Bank accounts are federally insured and rely on a bank's reserves and ability to borrow. Gains in the future value of an investment come from the borrower's gains on other investments, which can come from any number of sources. This means that future value investments don't require the risk valuation and elements of chance that other investments do; investors know what they're getting.
The more significant downside to future value investing is the limited returns it can generate. Bank interest grows an investment to its future value, but only provides a small return compared to more lucrative investments with higher risks, such as stocks, bonds and certificates of deposit. Besides accepting low returns due to the low level of risk, future value investors also maintain liquidity by being able to withdraw their investments at any time, losing a portion of the future value but getting money to spend as needed elsewhere.
Time and the Risk of Inflation
Future value investments, by definition, take time. They are very different from investments in stock that can generate large returns, or create large losses, in a matter of hours or days. Future value investments are often measured in months or years. This creates a risk due to inflation. Inflation refers to the tendency of goods to rise in price over time. This means that even as money grows toward its future value, the rise in prices depletes the value of that growth. Other types of investments, such as stocks, tend to guard against inflation.