What is a hard dollar?
An investor pays hard dollars to a brokerage firm for the services it rendered. Hard dollars are cash fees or payments usually set and known before the customer even deals with the broker. When we say hard dollars, we also consider set transaction charges, maintenance charges per month, and the money paid to the brokerage firm for its research.
And since we are already here talking about circumstances where the investor requires research from the brokerage, we say that investors can pay for its services with cash. They can also pay using the minimal commission dollars available with different brokerage firms. The customer can always allocate a portion of those commission dollars to other brokerage firms as service or research payment. This other option is called soft dollars.
Let us cite an example.
Let us say that you want your brokerage firm to do your research. You can pay for that by trading with the broker and produce commission dollars. On the other hand, you can also choose not to trade with your broker. Instead, you opted to give him a check payment. In this case, the first option is a soft dollar, and the latter is hard dollars.
But what is a soft dollar?
We mentioned soft dollars earlier, and you might already know how it works but let us explain more about it. It is an agreement between a client and another broker. It means that the client allocated commission funds to pay for research or other needs. A client can also instruct the soft dollar broker to find another broker for research. This scenario where the client instructs the soft dollar broker to pay another firm for research instead of sending a hard check demonstrates a soft dollar payment.
What is the difference between the two?
Some people get confused between the two because they are both related to payments. But they are entirely different things. First, hard dollars are different from soft dollars because they are tangible, physical, and actual payments in cash. On the other hand, soft dollars are made and paid through commission dollars made with a soft dollar broker. Hence, a client pays soft dollars within the commission revenue by making trades or deducting from any other transactions.
Why do other people choose hard dollars over soft dollars?
In mutual funds, investors pay for research and other included services in a soft dollar transaction. However, the fund does not provide information on these costs. It means that they are part of the trade costs. They affect the fund’s long-term performance. But if we are looking at it from a technical perspective, we can say that mutual funds give information on the research’s hard cost through the management fee. But here is the thing: you do not pay it from the management fee if it is paid using soft dollars. Some fund managers stress that the investors are solely responsible for every cost. The problem with soft dollars as research payment is it does not make an accurate cost analysis during the fund selection. Hence, we cannot determine them, and they are not equal.