What is a Basis Point?
A basis point (bp) equals 0.01%, so 100 basis points equal 1 full percentage point. When the Federal Reserve raises rates by 25 basis points, it means a 0.25% increase. This unit exists because small rate differences have enormous financial impact - on a $500,000 mortgage, a 50 basis point difference in interest rate changes the total interest paid over 30 years by roughly $50,000.
Basis Points in Fund Fees
Mutual fund expense ratios are often quoted in basis points. A low-cost S&P 500 index fund might charge 3 basis points (0.03%), while an actively managed fund could charge 75-100 basis points (0.75-1.00%). Over 30 years on a $100,000 investment growing at 7% annually, the difference between 5 bps and 80 bps in fees amounts to roughly $120,000 in lost returns due to compounding drag.
Why Basis Points Matter
Using basis points eliminates ambiguity. Saying a rate rose from 5% to 6% could mean a 1 percentage point increase or a 20% relative increase. Saying it rose by 100 basis points is unambiguous. Bond traders, central bankers, and fund analysts rely on basis points for precision. Even a 10 basis point shift in government bond yields can move billions of dollars in the global bond market.