Do ETF pay dividends?
ETFs pay dividends earned from the underlying stocks held in the ETF. An ETF that receives dividends must pay them to investors in cash or additional shares of the ETF. Dividends may be taxed at the long-term capital gains rate or the investor's ordinary income tax rate.
High-dividend ETFs may generate income
Dividend-paying ETFs can be a great tool for those looking to increase cash flow and diversify their investments. They offer a simple solution to getting exposure to a specific investing niche — in this case, stocks that pay a regular dividend.
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).
Qualified. To receive a qualified dividend, you must hold an ETF for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date and ends 60 days after that date. This is the last day when new owners can qualify for the next dividend.
Vanguard is a large investment advisor offering mutual funds and ETFs, many of which pay dividends. Most of Vanguard's ETF products pay monthly or quarterly dividends.
Disadvantages. However, dividend ETFs are not without pitfalls. One of the tradeoffs for consistent income and lower risk is frequently a lower potential for growth. Companies that regularly pay out dividends tend to be more conservative in reinvesting profits for expansion.
Dividend ETFs or Dividend Stocks: Which Is Better? Dividend ETFs can be a good option for investors looking for a low-cost, diversified and reliable source of income from their investments. Dividend stocks may be a better option for investors who prefer to choose their own investments.
| Symbol | Name | Dividend Yield |
|---|---|---|
| CYA | Simplify Tail Risk Strategy ETF | 117.07% |
| TSL | GraniteShares 1.25x Long Tesla Daily ETF | 87.25% |
| NGE | Global X MSCI Nigeria ETF | 85.38% |
| KLIP | KraneShares China Internet and Covered Call Strategy ETF | 64.28% |
Some ETFs might provide passive income given enough capital invested, but this depends on market conditions. Dividend ETFs can be a good passive income generator, but again, it depends on market conditions and how much you have invested and hold.
Allocating Dividends
If an ETF has 100 shares of a company outstanding, the investor who owns ten shares has the right to 10% of the dividends earned by the ETF. The financial institution managing the ETF will receive the distribution and pass it to investors, usually quarterly.
Why are my ETF dividends not qualified?
Nonqualified dividends: These dividends are not designated by the ETF as qualified because they might have been payable on stocks held by the ETF for 60 days or less. Consequently, they're taxed at ordinary income rates.
For ETFs held more than a year, you'll owe long-term capital gains taxes at a rate up to 23.8%, once you include the 3.8% Net Investment Income Tax (NIIT) on high earners. If you hold the ETF for less than a year, you'll be taxed at the ordinary income rate.
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
| Symbol Symbol | ETF Name ETF Name | % In Top 10 % In Top 10 |
|---|---|---|
| VIG | Vanguard Dividend Appreciation ETF | 32.18% |
| VYM | Vanguard High Dividend Yield Index ETF | 25.50% |
| VYMI | Vanguard International High Dividend Yield ETF | 14.60% |
| VIGI | Vanguard International Dividend Appreciation ETF | 35.23% |
The average dividend yield on S&P 500 index companies that pay a dividend historically fluctuates somewhere between 2% and 5%, depending on market conditions. 7 In general, it pays to do your homework on stocks yielding more than 8% to find out what is truly going on with the company.
ETFs and Dividends
The most basic example is the SPDR S&P 500 ETF (SPY A), which is not only the most popular ETF in existence but also a dividend payer. According to its prospectus, the fund puts all dividends into a non-interest bearing account until the time comes to make a payout.
Market risk
The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.
For most personal investors, an optimal number of ETFs to hold would be 5 to 10 across asset classes, geographies, and other characteristics.
ETFs offer advantages over stocks in two situations. First, when the return from stocks in the sector has a narrow dispersion around the mean, an ETF might be the best choice. Second, if you are unable to gain an advantage through knowledge of the company, an ETF is your best choice.
| Stock | Forward dividend yield |
|---|---|
| Exxon Mobil Corp. (XOM) | 3.5% |
| Johnson & Johnson (JNJ) | 3% |
| Procter & Gamble Co. (PG) | 2.3% |
| Home Depot Inc. (HD) | 2.4% |
Are ETFs good for passive income?
Another way to invest passively is with index funds. These investments are a mutual fund or exchange-traded fund (ETF) that aim to mirror the performance of an index of stocks or bonds. For instance, a stock index fund might track the performance of the S&P 500, a collection of about 500 of America's top companies.
In fact, an ETF called the Global X NASDAQ 100 Covered Call ETF (NASDAQ:QYLD), launched in 2013, currently boasts an eye-catching yield of 12%. While the ETF holds appeal for income investors, there are also several things that investors should be aware of before jumping in right after seeing that eye-popping yield.
You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all.
The Bottom Line
Investing 15% of your income is generally a good rule of thumb to meet your long-term goals.
Automatic dividend reinvestment plans (DRIPs) directly from the fund sponsor aren't yet available on all ETFs although most brokerages will allow you to set up a DRIP for any ETF that pays dividends. This can be a smart idea because there's often a longer settlement time required by ETFs.
