How the Use of Soft Dollars Affects Your Retirement Funds

The fundamental difference between soft and hard dollar (cash) payments is that the mutual fund will pass some of the business to a brokerage instead of paying the providers directly.

What Are Soft Dollars?

Payments made to brokerage firms through commission revenue rather than direct payments are known as soft dollars. However, the investing public generally views such arrangements negatively. Investors believe that buy-side firms should use their profits to pay expenses, making hard-dollar compensation more common.

How Does It Work?

X LLP provides Y Mutual with software that transmits investment information. Both companies have mutually agreed that Y Mutual will pay for these services by directing trades to a specific brokerage firm. The brokerage firm will charge an extra fee on Y Mutual’s transactions. The additional 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 worth billions daily, so they add up to a large amount of money pretty quickly.

Why Soft Dollars?

In the example above, Y Mutual would have had to make the payment directly, which would have required issuing a cheque. The cheque would have to be recorded in the company’s books, and the resulting costs would have to be passed on to investors. Soft dollars allow mutual funds to receive services without paying for them directly. The point is to hide expenses in trading costs and have investors pay for them without their knowledge. The overall cost of running the company will seem low, which appeals to many investors.

What It Means For Investors

Soft dollars make it extremely difficult for investors to compare the cost of using one mutual fund company over another. This is because soft dollar payments will appear as transaction costs. In the long run, using soft dollars means more business for the mutual fund 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 expenses from their profits rather than from investors' money. You are the investor if you save for your retirement using a mutual fund. Each soft dollar transaction takes a toll on your returns.