Soft Dollars and Other Hidden Costs

When you’ve been in the financial services industry for a while (and I would imagine that being in and around any industry has the same inherent circumstance) some topics flare up and become major issues for a brief time before retreating into the background again.

The focus becomes sharp and it feels like *this* particular issue could be the one that changes the way we will do business moving forward.

I was reminded of one of these issues last week at a conference I attended where it was mentioned that “soft dollars” are still a major component of revenue for mutual fund companies and broker-dealers.

So, what are soft dollars?

Soft dollar costs are expenses incurred by mutual funds and broker-dealers for research and other services provided by third-party vendors. These costs are “soft” because they are not paid for directly with cash, but rather through commission payments for executing trades or other services.

For example, a mutual fund may hire a research firm to provide market analysis and investment recommendations. Rather than paying the research firm directly with cash, the mutual fund may direct its broker-dealer to pay for the research with commission dollars generated from trades executed on behalf of the mutual fund. The broker-dealer then passes along the cost of the research to the mutual fund through higher commission rates or other charges.

Similarly, a broker-dealer may use soft dollar costs to pay for various services that benefit their clients, such as access to research reports or investment analysis tools. The broker-dealer may negotiate with third-party vendors to provide these services in exchange for directing trades to the vendor’s trading desk. The cost of these services is then passed on to the clients indirectly through higher commission rates or other charges.

When examined, the issue with soft dollars remains the same as it was almost twenty years ago when it seemed like an inflection point had been reached– the cost of these “soft dollars” is not included in the expenses disclosed to investors.

How a Soft Dollar Transaction Works

Suppose that an institutional investor pays a brokerage firm six cents per share in commissions. However, it might only cost three cents per share to perform the trade. The other three cents are soft dollars used to pay for additional services provided by the brokerage. In exchange for paying these higher fees, the institutional investor might receive access to research. (1)

If you want to find these costs disclosed… good luck!

The acknowledgment of these fees is often listed by mutual fund companies and broker/dealers in buried disclosure forms (fortunately Google makes it a lot easier to find these documents today) but the specific fees paid per trade (including markups/markdowns) are nearly impossible to find. And there are no regulatory requirements to disclose how much a trade costs you as long as it is “reasonable.”

If this feels slimy to you, it does to us too.

We pride ourselves on being fee-only fiduciary advisors. Fee-only fiduciary advisors are financial advisors who charge clients only for their advice and services, and they do not receive commissions or any other compensation based on the products or investments they recommend.

Fee-only fiduciary advisors generally do not have soft dollar costs because they do not receive any compensation from financial service providers. They are legally bound to act in their client’s best interests and to avoid conflicts of interest.

As such, they are prohibited from receiving any compensation, including soft dollar arrangements, that could potentially influence their recommendations to clients.

1. Chen, J. (2021, May 31). Soft Dollars: Definition, Arrangement Examples, Vs. Hard Dollars. Investopedia.com. https://www.investopedia.com/terms/s/softdollars.asp