Disappearing Money
Before we get to how money disappears, it is important to understand that regardless of whether the market is rising (a bull market) or falling (a bear market), supply and demand drive the price of stocks. And it's the fluctuations in stock prices (and the points at which you buy and sell shares) that determine whether you make money or lose it.
Buy and Sell Trades
If you purchase a stock for $10 and sell it for only $5, you will lose $5 per share. You may believe that that money goes to someone else, but that isn't exactly true. It doesn't go to the person who buys the stock from you.
For example, let's say you were thinking of buying a stock at $15, and before you do so, the stock price falls to $10 per share. You decide to purchase at $10, but you didn't gain the $5 depreciation in the stock price. Instead, you got the stock at the current market value of $10 per share.
In your mind, you may think that you saved $5, but you didn't actually earn a $5 profit. However, if the stock then rises from $10 back to $15, you will have a $5 (unrealized) gain.
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The same is true if you're holding stock and its price drops, leading you to sell it for a loss. The person buying it at that lower price—the price you sold it for—doesn't necessarily profit from your loss. That's because their entry point is the lower price and they must wait for the stock to rise above that level before making an unrealized (or realized) profit.
No one, including the company that issued the stock, pockets the money from your declining stock price. The money reflected by changes in stock prices isn't tallied and given to some investor. The changes in price are simply an independent by-product of supply and demand and corresponding investor transactions.
Short Selling
There are investors who place trades with a broker to sell a stock at a perceived high price with the expectation that it will decline. This is called short-selling.
If the stock price falls, the short seller profits by buying the stock at the lower price and closing out the trade. The net difference between the sale and buy prices is settled with the broker.
Although short-sellers profit from a declining price, they're not taking money from you in particular when you lose on a stock sale. Rather, they're conducting independent transactions and have just as much of a chance to lose or be wrong on their trade as investors who are long (own) the stock.
In other words, short-sellers profit on price declines, but it's a separate transaction from bullish investors who bought the stock and are losing money because the price is declining.
So the question remains: Where did the money go?
Implicit and Explicit Value
The most straightforward answer to this question is that it actually disappeared into thin air, due to the decrease in demand for the stock, or, more specifically, the decrease in enough investors' favorable perceptions of it to move the price down by selling.
But this capacity of money to dissolve into the unknown demonstrates the complex and somewhat contradictory nature of money. Yes, money is a teaser—at once intangible, flirting with our dreams and fantasies, and concrete, the thing with which we obtain our daily bread.
More precisely, this duplicity of money represents the two parts that make up a stock's market value: the implicit and explicit value.
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Implicit Value
On the one hand, value can be created or dissolved with the change in a stock's implicit value, which is determined by the personal perceptions and research of investors and analysts.
For example, a pharmaceutical company with the rights to the patent for the cure for cancer may have a much higher implicit value than that of a corner store.
Depending on investors' perceptions and expectations for the stock, implicit value is based on revenues and earnings forecasts.
If the implicit value undergoes a change—which, really, is generated by abstract things like faith and emotion—the stock price follows. A decrease in implicit value, for instance, leaves the owners of the stock with a loss in value because their asset is now worth less than its original price. Again, no one else necessarily receives the money; it simply vanishes due to investors' perceptions.
Explicit Value
Now that we've covered the above somewhat unreal characteristic of money, we cannot ignore how money also represents explicit value, which is the concrete value of a company.
Referred to as the accounting value (or book value), the explicit value is calculated by adding up all assets and subtracting liabilities. So, this represents the amount of money that would be left over if a company were to sell all of its assets at fair market value and then pay off all of the liabilities, such as bills and debts.
Without explicit value, the implicit value of the company would not exist. Investors' interpretation of the financial health and performance of a company is based on its explicit value. Explicit value is t
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What Are Soft Dollars?
What Are Soft Dollars?
Soft dollars are a means of paying brokerage firms for their services through commission revenue, as opposed to through hard-dollar direct payments.
The investing public tends to have a negative perception of soft-dollar arrangements. Many investors believe that buy-side firms should pay expenses out of their own profits. As a result, the use of hard-dollar compensation is becoming more common.
KEY TAKEAWAYS
Soft dollars are commission payments to a brokerage firm that are used, in part, to pay for other services such as research.
Soft-dollar transactions are frequently criticized for lacking transparency and hiding abuses.
Soft dollars are sometimes defended as providing access to a greater variety of research.
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.
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Under the right conditions, none of the above presents a problem for the Securities and Exchange Commission (SEC). The regulator is willing to permit soft-dollar transactions, provided that the investor gets good execution, and the commissions are reasonable.
Criticism of Soft Dollars
Mutual fund investors pay the costs of research and other bundled services provided in the soft-dollar transaction. Yet these costs are not disclosed by the fund. They are simply part of the costs of trades, and they impact the long-term performance of the fund.
Technically, the mutual fund would disclose the hard cost of research in its management fee. However, that charge is not paid from the management fee when it is paid for with soft dollars. The fund managers argue that institutional investors ultimately bear all of the costs. However, using soft dollars to pay for research doesn't allow investors to conduct an accurate cost analysis when selecting the fund.
Soft dollar values are not determinable, nor are they equal. What one investment manager receives in the form of services may differ from what another manager gets. That opens the door for conflicts and abuses. The mutual fund investors never know what portion of their transaction costs are applied to the soft services or their actual investment.
Although soft-dollar transactions are still widely used, there is a growing movement to eliminate them. That is especially true as financial reform and issues of transparency become more important in the industry.
Benefits of Soft Dollars
Soft dollars can provide some benefits to investors. One of the main arguments is that they offer access to a greater variety of research.
For instance, investment advisors can use all the research material obtained through soft dollars to benefit all of their clients. According to defenders of soft dollars, eliminating this practice could hinder research efforts by investment advisors and lower returns for their clients.
https://stockstrategy.net/
Stock Strategy
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Example of Soft Dollars
A mutual fund may offer to pay for research from a brokerage firm by executing trades at the brokerage.
Assume that a large-cap value fund wants to buy some research from XYZ Brokerage Firm. The fund may agree to spend at least $10,000 in commissions for brokerage services in return for the research, which would be a soft-dollar payment. If the fund simply wanted to buy the research, it might have to pay the brokerage firm $7,000 in hard dollars (cash) instead.
Real-World Example of Soft Dollars
In 2013, the SEC levied sanctions against New York brokerage firm Instinet, LLC. Instinet did not flag payments of more than $400,000 in soft dollars to San Diego-based advisor J.S. Oliver Capital Management. However, there were clear signs that the money was used for dubious purposes and not properly disclosed to clients.
The SEC found that associates at J.S. Oliver Capital had misused the soft-dollar payments. Ultimately, the SEC ruled that Instinet overlooked the misuse of the soft dollars and settled with the company for about $800,000.
Soft dollars are a means of paying brokerage firms for their services through commission revenue, as opposed to through hard-dollar direct payments.
The investing public tends to have a negative perception of soft-dollar arrangements. Many investors believe that buy-side firms should pay expenses out of their own profits. As a result, the use of hard-dollar compensation is becoming more common.
KEY TAKEAWAYS
Soft dollars are commission payments to a brokerage firm that are used, in part, to pay for other services such as research.
Soft-dollar transactions are frequently criticized for lacking transparency and hiding abuses.
Soft dollars are sometimes defended as providing access to a greater variety of research.
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.
https://stockstrategy.net/
Stock Strategy
Stock trading Strategy
Under the right conditions, none of the above presents a problem for the Securities and Exchange Commission (SEC). The regulator is willing to permit soft-dollar transactions, provided that the investor gets good execution, and the commissions are reasonable.
Criticism of Soft Dollars
Mutual fund investors pay the costs of research and other bundled services provided in the soft-dollar transaction. Yet these costs are not disclosed by the fund. They are simply part of the costs of trades, and they impact the long-term performance of the fund.
Technically, the mutual fund would disclose the hard cost of research in its management fee. However, that charge is not paid from the management fee when it is paid for with soft dollars. The fund managers argue that institutional investors ultimately bear all of the costs. However, using soft dollars to pay for research doesn't allow investors to conduct an accurate cost analysis when selecting the fund.
Soft dollar values are not determinable, nor are they equal. What one investment manager receives in the form of services may differ from what another manager gets. That opens the door for conflicts and abuses. The mutual fund investors never know what portion of their transaction costs are applied to the soft services or their actual investment.
Although soft-dollar transactions are still widely used, there is a growing movement to eliminate them. That is especially true as financial reform and issues of transparency become more important in the industry.
Benefits of Soft Dollars
Soft dollars can provide some benefits to investors. One of the main arguments is that they offer access to a greater variety of research.
For instance, investment advisors can use all the research material obtained through soft dollars to benefit all of their clients. According to defenders of soft dollars, eliminating this practice could hinder research efforts by investment advisors and lower returns for their clients.
https://stockstrategy.net/
Stock Strategy
Stock trading Strategy
Example of Soft Dollars
A mutual fund may offer to pay for research from a brokerage firm by executing trades at the brokerage.
Assume that a large-cap value fund wants to buy some research from XYZ Brokerage Firm. The fund may agree to spend at least $10,000 in commissions for brokerage services in return for the research, which would be a soft-dollar payment. If the fund simply wanted to buy the research, it might have to pay the brokerage firm $7,000 in hard dollars (cash) instead.
Real-World Example of Soft Dollars
In 2013, the SEC levied sanctions against New York brokerage firm Instinet, LLC. Instinet did not flag payments of more than $400,000 in soft dollars to San Diego-based advisor J.S. Oliver Capital Management. However, there were clear signs that the money was used for dubious purposes and not properly disclosed to clients.
The SEC found that associates at J.S. Oliver Capital had misused the soft-dollar payments. Ultimately, the SEC ruled that Instinet overlooked the misuse of the soft dollars and settled with the company for about $800,000.