Georgia DECA Advertising Practice Test

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What principle is illustrated by the scenario of saving $2,000 per year in an IRA with a 9% interest rate?

Simple interest
Compound interest
Fixed interest
Variable interest

The correct answer is: Compound interest

The scenario of saving $2,000 per year in an IRA with a 9% interest rate illustrates the principle of compound interest. Compound interest refers to the process where the interest earned on an investment is reinvested to generate additional interest over time. This means that not only does the initial amount (the principal) earn interest, but the interest that accumulates during previous periods also earns interest in future periods. In this case, by depositing $2,000 each year into the IRA and having it grow at a 9% interest rate, the account can compound annually, leading to a much greater total over time compared to simple interest, which only calculates interest on the principal amount without taking into account any interest earned previously. This principle is key for long-term investments, as it leverages the time value of money, allowing individuals to build wealth more effectively.