The theme this week on the One Minute Retirement Tip podcast is could you pass this basic financial literacy quiz? 

Today’s financial literacy quiz question is: Suppose you have $100 in a savings account earning 2 percent interest a year. After five years, how much would you have?

• More than $102
• Exactly $102
• Less than $102

The correct answer is More than $102. If you have $100 earning 2%, it will be worth $102 at the end of the first year. Now you’re earning 2% on $102 after that first year, so after year 2, your $100 original investment will be worth $104.04. And will continue earning the 2% on the higher balance amount each year thereafter. 

This question tests your understanding of compound interest. I call this the 8th wonder of the world and understanding compound interest is essential to both understanding the decimating impact of owning debt and the amazing results from having your money work for you as an investor. 

It’s also a BIG BIG reason why there’s truth in the phrase the rich get richer and the poor get poorer. If you have $10,000 and it earns 7% a year, I’ll double my money in about 10 years. Not too bad. Now I have $20,000. 

But if I have $1,000,000 and I earn the same 7% rate of return per year, I will also double my money in those same 10 years, but I didn’t make $10,000...I made another million. 

Compound interest is why debt should be avoided and you should start investing as soon as you can legally go to the bar. Because compound interest works both ways. 

That’s it for today, Thanks for listening! 

My name is Ashley Micciche and this is the One Minute Retirement Tip. 

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Tags: retirement, investing, money, finance, financial planning, retirement planning, saving money, personal finance