However, if you say that the 5.5% federal funds rate was raised by 25 basis points, that's simple. There's clarity. That's 5.75%, always and forever.
How basis points are used
Because basis points provide more clarity than using multiple different percentages in the same sentence, they're generally how increases and decreases in interest rates are expressed. This might be anything from a change in a mutual fund rate to an increase in the 30-year fixed mortgage rate.
For example:
- Your mutual fund saw an increase in interest of 3 basis points.
- The 30-year fixed mortgage rate rose by 25 basis points this month.
- The federal funds rate was dropped by 25 basis points for the first time in a year.
Using basis points also adds a lot of precision to a conversation, because it's a much smaller unit that's easier to express. When was the last time you said that your mutual fund gained 0.03% interest? Probably never -- that's a heck of a mouthful!
The tendency for people to round trailing decimals is very strong and it can create a lot of chaos when talking about fractions of percentages. So, instead of trying to discuss 0.03% of something, we just call it 3 basis points. Psychologically, it's a whole number, even though we know it represents a fraction of a percent.
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