How do ETFs account for dividends?
ETFs pay dividends just like any other dividend-paying stocks, and like individual stocks, these dividends are typically in the form of cash payouts, or issuance of further shares (aka as dividend reinvestment plan).
While not all ETFs pay dividends/distribution income, the vast majority do via quarterly distributions, and any stocks within the portfolio that pay a dividend, have these payouts pooled together. For example, by buying an ETF that invests in a blended mix of income-paying stocks, you’ll receive – within a single ETF trade - the income you would have otherwise received, had you invested directly in each of the underlying stocks.
Paid to shareholders on a pro rata (proportionate) basis, the amount you receive in dividends depends on the number of shares you own in an ETF. For example, if there are one million ETF shares available, and you as an individual shareholder own 100,000 shares, your 10% holding in the portfolio would be reflected in 10% of the total dividend payments.
Know how individual ETFs distribute dividends
ETFs will attribute differing priorities to chasing dividend-paying stocks, and just like regular stocks will have will differing distribution policies, as part of their overall strategy. For example, not all ETFs invest in stocks that pay dividends, and not all those that do - just like regular stocks - will always offer a traditional DRP program.
It’s important to check what type of ETF you’re planning to buy, and the dividend distribution policy of the fund provider (issuer). That’s doubly important if you’re an income investor, and receiving regular dividends to live on is integral to your individual portfolio construction.
As a case in point, even though InvestSMART’s ETF-based portfolios hold shares directly in the name of an individual shareholder (within a professionally managed account or PMA) – just as you would if you’d bought them direct - we do not participate in DRPs in the traditional sense.
How dividends get paid?
However, the full dividend paid by the underlying stocks still finds its way to your individual portfolio, and here’s how:
Instead of paying you a dividend immediately, the cash payments collected by an ETF fund goes into what’s called the ‘cash component’ of the portfolio. Once sufficient cash has been accumulated within the ETF fund, it is then redeployed within the portfolio, to ensure the cash weighting is kept in line with the weighting of the underlying model portfolio.
It’s through this rebalancing, that reallocates cash to any underweight positions in the portfolio – hence bringing it back into line with the model - that dividends will, at varying intervals get paid. In the case of InvestSMART’s ETF portfolios, you can either have dividends reinvested, or alternatively arrange for them to be paid out to your Nominated Bank Account, and other funds will do likewise on request.