A basis point is a mathematical term that means 1/100th of 1%.
Basis points are a way to discuss hundredths of a percent. If you cut 1% into a hundred equal pieces, each piece would be one basis point.
Accordingly, 50 basis points is half of 1%. One hundred basis points is 1%. Investor need to understand basis points in order to understand the difference in a bond return or the cost of an investment service.
Real estate loans and other forms of long-term lending also use basis points to express the cost of borrowing. Currency and options traders use basis points to compare investment propositions, since large-dollar transactions can have a big impact even at the sub-1% level of calculation.
Most ordinary investors will hear basis points cited in terms of an investment expense ratio. For instance, a mutual fund charging 1.25% per year in expenses is said to have a 125 basis point expense ratio.
Basis points are also used to describe a management fee. An investment advisor charging three-quarters of 1 percent per year could be said to have a 75 basis point management fee.
Finally, basis points are used to quantify a change in the yield of a bond.
If for instance the yield changes by half of 1 percentage point, that’s 50 basis points. If it changes by 1 percent — going from 3% to 4%, for instance — that’s a 100 basis point change.
Basis point math in regard to investment fees can be applied by figuring out 1% of a specific dollar amount, then dividing.
For example, if you have a portfolio worth $100,000 and pay your financial advisor a 75 basis point fee, first calculate 1% of $100,000. Of course, it’s $1,000.
Since 1% equals 100 basis points, now you know that your cost in dollar terms for managing that portfolio will be 75% of $1,000, or $750 per year.
In financial services, investment personnel will express this in writing with the abbreviation “BPS” or verbally as “bips” or “beeps.”
They’re still talking about hundredths of 1%, regardless of the context of the discussion.
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