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Soft dollaring is yet another reason to buy common stocks instead of mutual funds. It works like this- A mutual fund can pay an inflated
commission to a broker and in return get a kickback from that broker.

So for, example, Vanguard has a choice of buying 100,000 shares of GE for one of its funds through Goldman Sachs, which charges $.06/share in commissions and has a soft dollaring arrangement with Vanguard, or through a generic broker charging $.03/share with no soft dollaring.

Vanguard chooses Goldman, paying $6,000 for the trade instead of $3,000. In return, Goldman agrees that $1,000 of the commission will be soft dollared, that is, Goldman will provide $1,000 of some service to Vanguard. For this to be legal, the thing of value must generally involve investment research. So, for example, Goldman pays the annual fee for one of Vanguard's Bloomberg machines.

There are endless variations on such kickbacks. For example, institutional customers who play the soft dollaring game may demand their money management firm trade through certain brokers so that they, the client, can get comp'd. Unfortunately we individual investors can't call Fidelity and demand a kickback for the .034 shares of Starbucks they traded on our behalf! Clients also force brokers to make donations to nonprofits with a portion of the soft dollared trades.

And just as brokers kickback reasearch services to mutual funds, mutual funds may kickback trade volume to brokers who, for example, provide a useful research report about a stock. Portfolio managers actually have voting computer systems with an annual comp budget they spend through the year.

You don't hear much about soft dollaring in the media, and what you do hear is often wrong, since very few people really understand how it works.


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