Soft dollar

The term soft dollars is used in relationship to certain payments made by investment funds to their service providers. In contrast to hard dollars (actual cash), which have to be reported on the fund's books, soft dollars are incorporated into brokerage fees and the expenses they pay for are thus not reported directly.

For example, let's assume fund ABC Capital purchases computer equipment from XYZ Computers. Rather than paying XYZ for the computers, ABC adds fractions of a cent to the brokerage fees it pays for executing transactions through its broker, LMN Brokers. LMN then sends payment to XYZ. If ABC had paid XYZ directly, the transaction would have been designated as "hard dollar."

To the fund investors, the expense for the computers is never reported. Instead, the brokerage fees are higher by a fraction of a cent per share. However, because ABC trades large amounts of shares every day, the money quickly adds up. The amount of soft dollars a fund can spend is thus often high, amounting to billions of dollars each year for all investment funds in the US. Because hard dollars eventually end up being reported as part of the management fee the fund charges its investors, soft dollar transactions are also a way for funds to lower their apparent fees (even though in the end investors pay for the expense anyway).

Soft dollar transactions have incurred a lot of scrutiny lately, but they are legal and regulated by the Association for Investment Management and Research AIMR.