ETFs have always been viewed as good long-term investments. But they can also be a great option for investors looking to start earning dividends now. Especially new investors.
Wait. What is an ETF?
An exchange-traded fund (ETF) is a type of investment traded on an exchange, just like a stock. And you can buy into one any time during the trading day at whatever price it happens to be at the time. That's different from mutual funds, which are priced at the end of each trading day, no matter what time you initiate a buy.
Unlike stocks, one ETF can hold a collection of assets, just like a mutual fund. So an investor might own an ETF that holds hundreds of different stocks. Read: instant diversification. And if your ETF contains dividend-earning stocks, it could earn you some extra cash.
Tell me more about stock ETFs.
There are ETFs for every kind of investment, including bonds, commodities, currencies, and of course, stocks. Drilling down more, ETFs can even invest in stocks in a specific industry, like tech, energy, or consumer staples. And because they're a basket of investments, ETFs are usually more cost-effective vs. buying each holding within the ETF individually.
Plus, they don’t usually have a minimum investment requirement like mutual funds. So you can start investing in ETFs with just a little cash. Which is great for anyone just starting out.
Okay. How do ETFs pay dividends?
If an ETF holds dividend-paying investments, it'll pay dividends, too. Either in cash disbursem*nts or as reinvestments in additional ETF shares. The dividends from each of the stocks in your ETF would be collected in a pool, then disbursed to shareholders.
When do ETFs pay dividends?
Most ETF dividends are paid on a quarterly basis, but that’s not a required timeframe. The ETF issuer decides when dividends are paid to shareholders. That doesn’t mean you’ll have to guess when or if you’ll get dividends. You can find the dividend dates in every ETF’s prospectus. (Hint: the document all stocks, bonds, and mutual funds use to list investment details for the public.)
To confirm if you’ll receive dividends from your ETF, take a look at the ex-dividend date in the prospectus. This is the last date to invest in order to be eligible for the next dividend disbursem*nt. If your purchase date is the same or after the ex-dividend date, you’ll have to wait for the next round of disbursem*nts.
What do I need to know about taxes on dividends and ETFs?
Dividends are separated into two categories, with the main difference being tax rates:
Qualified dividends are taxed at the capital gains rate, which is usually lower than ordinary income tax rates. Depending on your filing status and income, you can expect a rate from 0% to 20%.
The catch: To collect qualified dividends, the ETF must have held the dividend-paying stocks for more than 60 days during the 121-day period that starts before the ex-dividend date. Aaaand you must have held shares of the ETF for more than 60 days before the dividend is issued. If the timing is off, your dividends will be taxed as ordinary income.
Non-qualified dividends are always taxed at your normal income tax rate. To calculate the amount of your non-qualified dividends, subtract your qualified ETF dividends from your total dividend amount.
FYI: If you’re considered a high earner, you might also notice a 3.8% Medicare tax deduction from your dividends. To make sure you’re fully prepared, read over our list of tax forms to know.
Sounds good. So how can I invest in ETFs?
Before you dive in, here are a few investment terms to get familiar with. Next, you’ll need to open a brokerage account. Once your account is up and running, it’s time to compare ETFs to find one (or more) that you want to invest in.
Just a heads up, there are tons of ETFs to choose from, and the comparison process can be a bit overwhelming. Luckily, most brokerage accounts have built-in tools to help you narrow down the options based on factors like where you live and which industry you’re most interested in.Once you’ve found the right ETF for you, head over to the trading section of your brokerage account, make your first investment, and wait for the dividends to start rolling in.
theSkimm
If you’re new to investing, ETFs are a good way to get started. Because they're budget-friendly and offer easy diversification. Oh, and if your ETF contains dividend-earning stocks, they can start paying off asap.
FAQs
Dividend-Paying Stock ETFs. Dividend ETFs, specifically those oriented toward income, solve two problems facing bond investors: inconsistent long-term yields and low growth of principal. Like bonds, well-constructed dividend ETFs that adequately control their risks can provide fairly consistent payouts.
Do dividend ETFs actually 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.
What is the downside of dividend ETF? ›
Cons. No guarantee of future dividends. Stock price declines may offset yield. Dividends are taxed in the year they are distributed to shareholders.
How do you live off ETF dividends? ›
If you want to live off ETF dividends, you'll need to consider the money you may have from Social Security benefits, pension benefits, 401(k)s, IRAs, and any other sources of income. Then, you can start to estimate how much you'll need to fill in the gaps with ETF dividends.
What I wish I knew about dividend stocks before buying ETFs and CEFs? ›
Since ETFs and CEFs typically must invest in a certain minimum number of holdings, and there are only so many quality high-yield stocks available, these funds' average dividend yields often end up being much lower than what can be achieved by selectively investing in individual stocks, particularly a select few within ...
Which ETF gives the highest dividend? ›
Top 100 Highest Dividend Yield ETFs
| Symbol | Name | Dividend Yield |
|---|
| FEPI | REX FANG & Innovation Equity Premium Income ETF | 20.41% |
| TSLP | Kurv Yield Premium Strategy Tesla (TSLA) ETF | 19.54% |
| BETH | ProShares Bitcoin & Ether Market Cap Weight Strategy ETF | 18.57% |
| JPMO | YieldMax JPM Option Income Strategy ETF | 18.36% |
93 more rowsAnd one of the world's most popular index funds, the Vanguard S&P 500 ETF (VOO), happens to pay a dividend. However, some income-focused investors may prefer to focus on other funds that pay more than the VOO dividend.
Why is ETF not a good investment? ›
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.
Is it better to buy dividend stocks or ETF? ›
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.
How many dividend ETFs should I own? ›
Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification.
To generate $5,000 per month in dividends, you would need a portfolio value of approximately $1 million invested in stocks with an average dividend yield of 5%. For example, Johnson & Johnson stock currently yields 2.7% annually. $1 million invested would generate about $27,000 per year or $2,250 per month.
Can I live off the interest of $100,000? ›
Interest on $100,000
If you only have $100,000, it is not likely you will be able to live off interest by itself. Even with a well-diversified portfolio and minimal living expenses, this amount is not high enough to provide for most people.
Do you pay taxes on ETF dividends? ›
Dividends and interest payments from ETFs are taxed like income from the underlying stocks or bonds they hold. For U.S. taxpayers, this income needs to be reported on form 1099-DIV. 18 If you profit by selling shares in an ETF, that is taxed, like when you sell stocks or bonds.
What are the cons of ETF? ›
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
How long do you have to hold an ETF to get a dividend? ›
Types of dividends
These dividends are paid on stock held by the ETF, which must own them for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.
Are dividends from ETFs qualified dividends? ›
ETF dividends are taxed according to how long the investor has owned the ETF fund. If the investor has held the fund for more than 60 days before the dividend was issued, the dividend is considered a “qualified dividend” and is taxed anywhere from 0% to 20% depending on the investor's income tax rate.
How often do dividend ETFs pay? ›
Dividend-paying exchange-traded funds (ETFs) have been growing in popularity, especially among investors looking for high yields and more stability from their portfolios. As with stocks and many mutual funds, most ETFs pay their dividends quarterly—once every three months.
Do dividend funds pay dividends? ›
Dividend funds are paid out after fees, meaning that the best dividend mutual funds should have low expense ratios and high yields. Dividend-paying mutual funds tend to focus on large, well-established companies with a strong track record of paying dividends or that are expected to increase their dividend payments.
Do ETFs automatically reinvest dividends? ›
Dividend reinvestment can be done manually, by purchasing additional shares with the cash received from dividend payments, or automatically through dividend reinvestment plans. Automatic dividend reinvestment plans (DRIPs) directly from the fund sponsor aren't yet available on all ETFs.
