WSJ: What Is a Basis Point and Why Is It So Important?


Investment professionals regularly refer to "basis points" when discussing things like bond yields and mutual funds.

In the bond market, if the yield of a Treasury note rises to 1.05% from 1% it is said to have moved by five basis points or, as some abbreviate it, five "bips."

Why does this seemingly tiny unit of measure—one basis point is equal to one one-hundredth of a percentage point—get so much attention? It's pretty simple: Basis points can add up to a lot of money for both individual investors and institutions.

A single bond trade may be worth tens of millions of dollars, so tiny movements in prevailing interest rates can have a big dollar impact. For a $10 million bond, a move of one basis point can change the price of a bond by hundreds of dollars, depending on prevailing interest rates and the time to maturity.

Investors also refer to basis points when discussing the cost of mutual funds and exchange-traded funds. Typically, fund expenses are expressed as an annual percentage of assets. For instance, the "Investor" share class of Vanguard Total Stock Market Index, the largest stock mutual fund, has expenses of 0.17%, or 17 basis points.

When people compare fund expenses, they measure the difference in basis points. A fund with expenses of 0.45% is said to be five basis points more expensive than one with a 0.40% ratio. That difference in expenses might seem small, but on $10,000 invested over 20 years, it can add up to hundreds of dollars saved, depending on returns.

See original story here.

Post a Comment