How the Use of Soft Dollars Affect Your Retirement Funds

The real difference between soft dollar and hard dollar (cash) payments is that the mutual fund will pass on some of the business to a brokerage instead of making a direct cash payment to the providers.

How It Works

X LLP provides Y Mutual with software that transmits investment information. Both companies have mutually agreed that Y Mutual will make the payment for these services by directing trades to a specific brokerage firm.  The brokerage firm will charge an extra fee on Y Mutual’s trades. Money from the extra fee will be sent to X LLP as payment for the services provided. Usually, the added fees amount to a fraction of a cent, but Y Mutual trades shares amounting to billions every day, so it sums up to a large amount of money pretty quick.

Why Soft Dollars?

In the example above, Y Mutual would have had to make the payment directly, which would require the writing of a cheque. The cheque would have to go into the company’s books, and the resultant costs would have to be passed on to the investors. Soft dollars provide a way for mutual funds to receive services and not have to pay for them directly. The point is to hide expenses in trading costs and have investors pay for it without their knowledge. The overall cost of running the company will seem low, which is appealing to many investors.

What It Means For Investors

The use of soft dollars makes it extremely difficult for investors to compare the cost of using one mutual company over the other. This is because soft dollar payments will appear as the cost of transaction. In the long run, the use of soft dollars means more business for the mutual company. However, there is a growing negative perception vis-à-vis the use of soft dollars. The investing public argues that mutual funds should pay for the expenses using their profits instead of using investor money. If you are saving for your retirement using a mutual fund, you are the investor. Each soft dollar transaction takes a toll on your returns.