Fixed income exchange-traded funds (ETFs) pay interest rather than dividends. Nonqualified dividends are common in real estate investment trust (REIT) ETFs (although a portion may be qualified).
Do ETFs pay dividends?
The seemingly straightforward bond ETF may be the most misunderstood investment in recent years.
Bond-related exchange-traded funds account for a little more than a quarter of the $42 billion invested in ETFs in Canada, and four of the top ten ETFs are bond-related. Bond ETFs have clearly proven to be a more efficient and cost-effective alternative to bond mutual funds and buying bonds individually.
But, if the questions I get from readers are any indicator, some people who buy bond ETFs aren’t quite aware of how they function. To be clear, this edition of the Portfolio Strategy is intended to serve as a bond ETF owner’s guide.
An exchange-traded fund (ETF) is a vehicle for investing in any of a number of indexes that track bonds of various kinds, including those issued by governments and both blue-chip and less financially solid firms. Investors should get the return of the bond ETF’s underlying index, minus the management expense ratio and any fees levied by an investment adviser (not applicable to do-it-yourself investors).
Because bond ETFs move like stocks, brokerage trading commissions must be factored in. It’s worth noting that certain brokers now offer commission-free ETF trading (see tgam.ca/DFxL for more information).
Some bond ETFs are designed to provide comprehensive, diversified coverage of the entire bond market, including government and corporate bonds. Other products are aimed at allowing investors to customize their bond portfolios. They may, for example, mix low-yielding but safe short-term government and corporate bonds with real-return bonds to safeguard against inflation and high-yield bonds to boost returns (and risk).
Bond ETFs, like bonds, will appreciate in value as interest rates decrease and decline as rates rise. Bond ETFs, on the other hand, track their respective bond indexes without ever maturing, whereas bonds will ultimately mature and give you back your investment.
Many bond ETFs pay interest on a monthly basis, despite the fact that individual bonds normally pay only twice a year. Some ETFs pay out the same amount of money every month, while others change the amount of money they pay out.
Interest income is the primary source of income, but if you purchase a growing ETF, you may also enjoy capital gains and a tiny return of capital. This is due to the accounting regulations for ETFs that receive a large amount of fresh money.
At the low end, a bond ETF holding short-term bonds can be purchased for as little as 0.17 percent. It’s not clear why, but MERs for ETFs that contain longer-term bonds, corporate bonds, and high-yield bonds are higher. The top end of the market has MERs of roughly 0.65%, compared to an average of 1.25% for the 10 largest bond mutual funds.
Small investors are already at a disadvantage in the bond market: Individual investors pay a lot more for bonds than institutional investors, such as those who manage bond ETFs. The higher the yield, the lower the price paid for the bond.
Do not make the error of looking for a bond ETF stock quote and estimating your actual return based on the yield displayed. This yield is calculated using interest payments over the preceding 12 months and the bond ETF’s current share price. This so-called distribution yield, similar to the coupon on a bond, can be used to estimate how much income you can expect from the ETF. A bond’s interest payments are represented by the coupon.
The yield to maturity, which can be found on the product profiles that all businesses selling exchange-traded funds provide on their websites, is the right measure of a bond ETF’s return. Because of the different assumptions that go into the computation, yield to maturity is an estimated number. Still, as one ETF industry insider puts it, “that’s the best you can do” when it comes to calculating your yield. To achieve a net return, subtract the management charge from the indicated yield to maturity.
Despite this, some investors continue to prioritize distribution yield over yield to maturity, which is understandable. Today, the distribution yield is almost always significantly higher. Take the iShares DEX Universe Bond Index Fund (XBB), Canada’s largest bond fund: The distribution yield is 3.6 percent, with a 2.3 percent yield to maturity.
What’s the deal with the discrepancy? Because many of the bonds in the XBB portfolio were issued when interest rates were higher than they are now. As a result, the issue price of these bonds has climbed above its issue price, but it will gradually return to that level as the maturity date approaches. This drop in price is accounted for in yield to maturity, which is a total return that incorporates both interest and predicted price movements in bond ETF shares.
It’s worth noting that the yield to maturity isn’t always lower than the distribution yield. We could witness a reversal of this pattern if interest rates rise rapidly.
- Averaging the interest payments produced by bonds in a portfolio based on their weighting. Price changes for the bonds are not taken into account.
- Weighted average duration: A measure of interest-rate sensitivity. If rates rise by a single percentage point, however many years of duration a bond portfolio has on average, that is how many percentage points it will decline in price (the opposite applies, too). XBB has a 6.7-year duration, which means that a one-point increase would result in a 6.7-point drop. The durations of the iShares family’s short and long-term bond ETFs are 2.6 and 13.7 years, respectively.
- The average time period over which the bonds in the ETF will mature is known as the weighted average term.
- Ratings: Indicates how bond rating organizations rated the bonds in your portfolio. Triple-B and higher are regarded as excellent. Less than that will yield better returns, but at the cost of increased risk.
The following is a list of exchange-traded funds (ETFs) that track Canadian market bond indexes that are listed on the Toronto Stock Exchange (TSX).
Are dividend-paying ETFs better?
Dividend ETFs Have a Lot of Advantages. ETFs that pay dividends have a variety of appealing features. Dividend ETFs, in particular, may save investors a lot of time and potential difficulties when compared to holding individual companies, in my opinion.
When ETFs pay dividends, what happens?
ETFs may get dividends and interest from the securities they own, as well as capital gains or losses when they sell them. The ETF’s expenditures may reduce its revenue. Any leftover income or capital gains are distributed to unitholders as distributions, which are taxed at the investor’s marginal tax rate. This is preferable to the income being kept by the ETF and taxed at the highest marginal tax rate. The ETF’s income is dispersed in the same way it is earned: as interest, Canadian dividends, overseas income, or net capital gains – or a mix of the four.
What role do dividends play in ETFs?
ETFs (exchange-traded funds) pay out the entire dividend from the equities owned within the fund. Most ETFs do this by keeping all of the dividends received by underlying equities during the quarter and then paying them out pro-rata to shareholders.
Are qualified dividends paid by ETFs?
ETF dividends are taxed based on the length of time the investor has owned the ETF. The payout is deemed a “qualified dividend” if the investor held the fund for more than 60 days before the dividend was paid, and it is taxed at a rate ranging from 0% to 20%, depending on the investor’s income tax rate.
What ETFs pay dividends every month?
The Invesco S&P 500 High Dividend Low Volatility ETF (SPHD) seeks out high-dividend-paying equities with low volatility. It puts 90% of its money into common stocks of businesses in the S&P 500 Low Volatility High Dividend Index. Consumer defense and utilities are the focus of the fund. Among the holdings are:
Vanguard, do ETFs pay dividends?
The majority of Vanguard exchange-traded funds (ETFs) pay dividends on a quarterly or annual basis. Vanguard ETFs focus on a single sector of the stock market or the fixed-income market.
Vanguard fund investments in equities or bonds generally yield dividends or interest, which Vanguard distributes as dividends to its shareholders in order to maintain its investment company tax status.
Vanguard offers approximately 70 distinct exchange-traded funds (ETFs) that specialize in specific sectors, market size, international stocks, and government and corporate bonds of various durations and risk levels. Morningstar, Inc. gives the majority of Vanguard ETFs a four-star rating, with some funds receiving five or three stars.
Which REITs pay dividends every month?
- REITs (real estate investment trusts) are an excellent way to earn consistent income.
- Only a few REITs pay dividends on a regular basis, such as monthly or quarterly.
- AGNC Investment Corp. (AGNC) and STAG Industrial are two of the most well-known monthly dividend payers (STAG).
- Other monthly dividend REITs, such as Apple Hospitality (APLE) and Bluerock Residential Growth (BRG), have stopped paying dividends or have ceased them entirely (BRG).
Is it wise to invest in REIT ETFs?
These ETFs make investing in REITs simple. REITs have historically provided investors with above-average dividend income and price appreciation, resulting in good overall returns. Meanwhile, ETFs make it simple to invest in the REIT industry by giving investors broad exposure to the most popular REITs.
Are there year-end payouts for ETFs?
Is there a difference between capital gains and dividend payouts in ETFs? ETFs, like mutual funds, distribute capital gains and dividends (typically in December each year) (monthly or quarterly, depending on the ETF).