\u201cTeachable moment\u201d is a buzzword these days. So I\u2019ll sprinkle some nutritional content into my column today lest you accuse me of piling on just more empty calories during the holiday season. And thus I introduce the term \u201cbasis point.\u201d It\u2019s an easy concept, and it\u2019s a mystery to me why it isn\u2019t taught in junior high school to promote some basic level of financial literacy. It\u2019s an essential term if you borrow money, lend money, invest, speculate, or just want to know what the heck is going on in the world.<\/p>\n
Incidentally, the topic comes as a suggestion from a Chinese business owner. We were swapping tutelage in Mandarin for help in business English. The term \u201cbasis point\u201d came up, and my counterpart requested that I write about it. So this column is part of my \u201clanguage exchange\u201d obligation.<\/p>\n
I\u2019ll start with a dry definition, but if you don\u2019t like my definition, don\u2019t run away, since I\u2019m going to backfill it step-by-step. But we\u2019ll get the defining out of the way by stating that a basis point equals one-hundredth of a percentage point.<\/p>\n
Yeah, I see you giving me that look. The look that says, \u201chuh?\u201d Or, maybe, \u201cwhy should I care?\u201d <\/p>\n
But I\u2019ll disarm you with my roguish charm, flashing straight teeth and a cocked smile, and I\u2019ll keep explaining it. <\/p>\n
Here\u2019s the deal: \u201cPercent\u201d is a loaded term. And it\u2019s more invasive than crab grass: The entire world is built on contracts and agreements and analysis and terminology that involve percentages.<\/p>\n
Here\u2019s how percentages can lead us astray: Let\u2019s say you\u2019re reading in the news that a tax rate is being increased from 10 percent of income to 12 percent of income. The reporter refers to it as a \u201c2-percent\u201d tax increase, since 12 minus 10 is, indeed, two. But the increase in tax payments in this example isn\u2019t 2 percent, it\u2019s actually 20 percent!<\/p>\n
It\u2019s easy to illustrate with numbers: If you pay a 10 percent tax on $100 of income, your tax is $10. If the tax rate goes up to 12 percent, then you\u2019ll pay $12 instead of $10. So you\u2019re paying $2 more under the new way than the old way. The increase, $2, is fully a 20-percent increase over the old payment of $10. Just divide $2 by $10, and there\u2019s your answer; 0.2, or 20 percent.<\/p>\n
Anyway, how would we express the increased rate from 10 percent to 12 percent? Well, I would say it is an \u201cincrease of 200 basis points.\u201d That\u2019s nice and clean. It gets around a lot of semantic pitfalls. That\u2019s why the pros use it.<\/p>\n
I\u2019ve used big, fat, round numbers thus far, but basis points are more typically used for little, tiny, exact numbers. For example, let\u2019s say you are shopping for a mortgage. The loan officer offers you a loan at a 5.0 percent interest rate if you sign the papers on Monday, but if you wait until Tuesday, the rate will go up by 15 basis points. And that\u2019s the way he will probably say it, \u201c15 basis points.\u201d<\/p>\n
What he\u2019s saying is that the loan rate is going up from 5.0 percent to 5.15 percent. It\u2019s easy to eyeball where those basis points landed. There\u2019s no trickery here, it\u2019s as simple as it looks.<\/p>\n
Let\u2019s say you call again on Wednesday to check rates. He tells you that the rate just fell by 2 basis points. What\u2019s the new rate? Well, we take the 5.15 percent rate from Tuesday, and subtract 2 basis points, which puts us at a 5.13 percent rate. Then let\u2019s say on Thursday the rate goes up by 1 basis point; this will put us at 5.14 percent.<\/p>\n
Hey, is that all there is to the basis point gig? Yep. <\/p>\n
Why does this matter so much? Because the pros who deal with this stuff usually don\u2019t have an endless amount of time to go around and around in circles chasing misconceptions about percentages. You\u2019ll have an easier time \u201ctalking turkey\u201d with them if you know what a basis point is. <\/p>\n
Furthermore, next year is going to be one heck of a humdinger on the economic front, and if you want to follow the serious press you\u2019ll note the term \u201cbasis point\u201d is used all the time.<\/p>\n
I\u2019ve seen a lot of problems, some of them quite expensive, that could have been avoided by a basic understanding of basis points.<\/p>\n
[I]Visit Ed Stephens Jr. at [URL=\u201dhttp:\/\/tropicaled.com\u201d]TropicalEd.com[\/URL]. Ed is a pilot, economist, and writer. He holds a degree in economics from UCLA and is a former U.S. naval officer. His column runs every Friday. [\/I]<\/p>\n","protected":false},"excerpt":{"rendered":"
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