In terms of financial industry jargon, the term basis points is one you’ll hear often, if not more than ever these days. If you have ever applied for a mortgage, talked to a traditional financial advisor, or read/listened to financial market commentary, you’ve probably heard basis points used to describe advisory fees or interest rates.
It all comes down to percentages. Basis points are intended to be an easier way to specifically describe changes in interest rates. And particularly, small changes. For example, let’s take the percentage: 0.01%
You might say that out loud as “zero point zero one percent” or “point zero one percent”, and you’d be correct either way. But you could also just call this, “one basis point”. In financial markets, interest rates are discussed so often that the latter just becomes a much easier way to talk, particularly among industry peers.
So to make this as simple as possible, just remember that every 1% = 100 basis points. You may also see basis points abbreviated even further to “bps” or even “bips”. If mortgage rates drop from 4% to 3.25% for instance, you’d likely hear that stated as a 75 basis point drop.
As an investor, one of the most important reasons to understand the term basis points is when someone is referring to fees. Whether it’s fees specific to a particular investment (like a mutual fund in your 401k or IRA), or fees an advisor charges for their services, it can be easy to gloss over in conversation.
Basis points may be used to describe the internal fees related to a particular investment option in a retirement plan, for instance. You might see these fees referred to as a fund’s expense ratio, and expressed as a percentage. All this means is the percentage of the amount invested that will go toward that fund’s internal fees. If a fund has a 0.50% expense ratio (50 basis points), then $0.50 of every $100 invested in that fund will go toward fund fees.
When it comes to advisory services, traditionally speaking, financial advisors tend to charge asset-based fees that are expressed as a percentage of managed assets. If you were hiring a traditional advisor to manage a $100,000 account for you, you might expect to be charged an annual fee of 1%, or 100 basis points, which would be $1,000 in this case. As that balance hopefully grows over time, the 1% fee remains constant, but the actual dollar amount increases because of the increased balance.
Have a question about fees you might be paying or interest rates? Talk to a blooom advisor!
Published on July 28, 2021