How do dividends work in ETFs?

Do ETFs pay dividends the same way individual stocks do? If so, how often and how much?

The simple answer to that question is, yes.

ETFs pay dividends the same way any dividend-paying stock would, but there are some points you may want to consider if the high dividend yield is a key focus in your investment strategy.

The different types of ETFs

If you’ve visited our ETF comparison page, you will have seen a range of ETF types to choose from. To summarise, Australian or International Broad Based ETFs track a broad index (eg. the S&P/ASX50) either in Australia or internationally, respectively.

Sector ETFs invest in a particular sector, for example,  materials, property or healthcare. While strategy ETFs focus on a particular investment style or strategy such as maximised capital growth, or defensive assets.

Commodities focus on physical commodities like gold or other precious metal or agricultural goods and currency-ETFs track how the AUD is performing against other currencies.

Dividend ETFs fall under the ‘strategy’ category.

Compare Strategy Based ETFs with Canstar

How often do ETFs pay dividends and how does it work?

Typically, ETFs will pay out dividends quarterly. Any stocks within the portfolio that pay out a dividend have these payouts pooled together. Like individual stocks, these dividends may be in the form of cash payouts, or issuance of further stocks.

The amount an investor gets in dividends is dependent on how many shares of the ETF they own – for example, if 1,000 shares of an ETF are available and a single investor owns 10, then they would hold 1% of the portfolio, and thus be entitled to 1% of dividend payments.

The different types of dividend ETFs?

Dividend-ETFs fall under the Strategy Based ETF category, but there are several more subcategories of dividend ETFs. These range from high dividend yield, to dividend aristocrats, hybrid dividends and more.

If ETF fund manager’s primary goal is investing in ETFs that will result in high/frequent dividend payouts, there are a couple of ways to do this. Fund managers may invest in companies that have long records of paying high dividend yields, such as dividend aristocrats. This is the more conventional approach to dividend-focused strategies. Alternatively, managers may opt for a ‘dividend harvesting’ strategy. Dividend harvesting is particularly popular amongst day traders, and involves purchasing stocks as they are about to pay out dividends, before reselling them.

Pros & Cons of Dividend-Paying ETFs:

Pros:

• High-yield dividend ETFs may be a way for investors to access income, especially at times when interest rates are particularly low
• Low cash rates typically affect dividend ETFs less negatively than property/fixed income ETFs
• ETFs, in general, typically provide greater diversification, which can help hedge risk
• Investors don’t have to worry about tracking stocks, as this is handled by the ETF index or a fund manager

Cons:

• In passively managed dividend-ETFs (and sometimes actively managed ones) stocks are often sold when there are dividend cuts, so stocks may be sold when the price is lower and at other inopportune times
• Annual costs, especially on actively managed ETFs, may be higher
• Investors have no input on what the ETF contains, stock-wise. They may choose the strategy/theme but day to day, stock decisions are determined by the manager of the ETF

So, if dividend payouts are an important part of your portfolio construction and investment strategy, you don’t have to rule out ETFs.

Dividend ETFs may offer a way to further diversify your portfolio and provide a source of income, but like any investment they are not without risk.

There are many factors to consider when choosing an ETF or an investment strategy at large.

You should always do your due diligence before making any investment decisions, and when in doubt contact a professional financial advisor.

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