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A basis point is one hundredth of a percentage point, or 0.01%. It is used to discuss small fluctuations in equity indexes, interest rates, and yields on fixed annuities. Many financial analysts work with basis points, and you may also hear them referred to in news broadcasts about financial issues. By understanding what, exactly, a basis point is, you can more easily comprehend discussions which might otherwise seem entirely mysterious.
There are several advantages to referring to changes in basis points, rather than percentages. The first is that basis points are absolute and clear. For example, one could say equally correctly that interest rates rose 20%, from 5% to 6%, or that interest rates rose 1% from 5% to 6%. This can get a bit confusing, but it's much more simple when basis points are used, because one can say that interest rates rose by 100 basis points, providing instant clarity. Basis points can also be used to discuss very small increments of change without having to throw around challenging numbers. A rise in interest of 0.38%, for example, is perhaps better understood as 38 basis points.
While difference of of something like 20 basis points might seem small, it can reflect a radical change when a lot of money is involved. Small differences in interest rates can translate into huge gains or losses for investors, and it is important for average consumers to pay attention to them as well. When you plan on saving money in something like a savings account, shop around for good interest rates, as a difference of 50 basis points, for example, can represent a lot of money in the long term. The energy that consumers spend on seeking out good interest rates will ultimately pay off.
When you hear any discussion which involves basis points, remember that one basis point is equal to 0.01%, and 100 basis points are equal to 1%. This can help you visualize statements like “the Fed raised interest rates by 25 basis points to 3.25%.” Since you know that 25 basis points is equal to .25%, you know that the former interest rate was 3%. You may also hear a basis point referred to as a permyriad. This usage is somewhat unusual, but it's useful to be prepared.
Some consumers may be given information about interest on loans and lines of credit in basis points. A credit card company, for example, may inform its customers that late payments will result in an interest rate raise of 250 basis points. This can be used as a tactic to confuse consumers who are not informed about financial terminology, and if you're wise to the meaning of a basis point, you can save yourself some money.
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