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What Your Financial Calculator Must Do

Scott Rothbort

Any serious finance student (or serious self-directed investor) must have a serious calculator. When it comes to finance and investing, you will need to do a heck of a lot more than just add, subtract, multiply and divide. So if you're serious about managing your investments like a pro, make sure you pick up a financial calculator that, at the very least, can perform the following five functions.

1. Present Value

Definition: Present value is the current value of a certain amount in the future, given an interest rate which is compounded with some rate of frequency. This is sometimes referred to as "discounted value."

Practical scenario: Say that you recently got married and want to buy a house in five years. (Don't miss "From the S&P to Tiffany: Big Plans? Start Investing Now") You determine that you will need to have a down payment of $60,000 in five years to buy a house in your targeted price range. How much will you need to invest today in a certificate of deposit (CD) for five years that pays an annual interest rate of 5% on a semiannual basis to fund that future down payment?

Formula:

PV = Present Value; FV = Future value; i= annual interest rate; t = years and n = frequency of compounding (2 for semiannual, 4 for quarterly)

Answer: You will need to invest $46,871.90 today.

2. Future Value

Definition: Future value is the reverse of present value. Future value is the amount to which an investment will grow, given an interest rate which is compounded with some rate of frequency.

Practical scenario: You have $10,000 to invest today. If you invest the capital in an index fund for ten years. If the fund has historically earned 9% on an annual basis, how much would you expect that investment to grow to in ten years? (Don't miss " How to Measure Your Investment Performance")

Formula:

Answer: Your $10,000 will grow to $23,673.63 if it earns 9% a year for ten years

3. Future Value of an Ordinary Annuity

Definition: An annuity is a stream of payments or investments that is made on a periodic basis. The future value of the annuity is the sum of all the future values of the individual investments.

Practical scenario: You want to save money for your child's education. If you contribute $2,000 per year for 17 years into a mutual fund that you expect to earn 8% per year, how much money will you have once your son or daughter is ready to enter college?

Formula:

A= annuity payment

Answer: In 17 years, you will have $67,500.45 in the education fund.

4. Present Value of an Ordinary Annuity

Definition: The present value of an annuity is the current value of a stream of future payments

Practical scenario: How much will it cost today to purchase an annuity contract that pays $5,000 a year for 25 years, assuming an investment rate of 6%.

Formula:

Answer: Today, it should cost you $63,916.78.

Note: This formula can also be used to help calculate the monthly payment for a mortgage, when the PV is known. A good financial calculator will have this functionality built in.

5. Percentage Change

Definition: The percentage change between two numbers.

Practical scenario: You want to see how your portfolio of investments have performed. You started the year with $125,000 and ended with $138,500.

Formula:

Answer: Your portfolio grew by 10.8% this year.

Secondary Functions

A good financial calculator will also have the following real-world applications built-in:

If you're serious about managing your money and investments, you need a calculator than can perform some serious functions. There are many financial calculators that would serve the purposes discussed above, and they are easily obtained at retailers such as Staples (SPLS Quote) and Amazon.com (AMZN Quote).

My personal choice is the calculator that I have used for almost twenty five years: the HP12C made by Hewlett-Packard (HPQ Quote). I have this specific model at all of my homes and offices, and I even take it on vacation. That said, feel free to shop around because Texas Instruments (TXN Quote) also makes a few excellent models.