ETFs pay dividends the same way any dividend-paying stock would, but there are some points you may want to consider if high-dividend yield is a key focus in your investment strategy.
The different types of ETFs
There is a range of ETF types that you can choose from when investing. To summarise:
- New Zealand or International Broad Based ETFs track a broad index (eg. the S&P/NZX50) either in New Zealand or internationally, respectively
- Sector ETFs invest in a particular sector, for example, materials, property or healthcare
- 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 metals or agricultural goods
- Currency-ETFs track how the NZD is performing against other currencies
Dividend ETFs fall under the strategy category.
How often do ETFs pay dividends and how do payments work?
Typically, ETFs 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 depends on how many shares of the ETF they own – for example, if 1000 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 an ETF fund manager's primary goal is investing in ETFs that will result in high/frequent dividend payouts, they have a couple of options. They 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
Should dividend-paying ETFs be a part of my investment strategy?
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.