What's a dividend and what's a distribution? Find out the difference between the two and how they work when it comes to ETFs.
What is a dividend?
By definition, a dividend is a distribution of profits by a company to its shareholders and for many, is akin to income that is generated from their investments.
What is a distribution?
A distribution is the share of income an investor receives from their ETF or managed fund.
An ETF is essentially a diversified set of securities and as such, acts as a microcosm of a whole portfolio of investments. In the same way you may receive income (known as dividends) from individual investments within a portfolio, an ETF receives income from the companies or securities it holds.
For example, if you purchase an ETF that tracks an index comprising the ASX's largest companies by capitalisation, you are holding a portfolio of shares from each of these large companies in proportion to their size within the index.
When these companies pay dividends throughout the year, the provider that issued your ETF collects the payments from every single company and holds them until the ETF's income distribution date. These collective payments are known as distributions and represent your share of income earned by the investments within your ETF.
The income you will receive from your ETF is indicated by the distribution yield, and will be less any management costs. You can generally elect to receive the ETF distribution in cash or for the distribution to be reinvested into the same ETF through additional units if the option is available1.
When will I receive my distribution and how does it affect the ETF price?
ETF distribution dates vary but they are usually quarterly, half-yearly or yearly. You can find this information in the product disclosure statement.
The price of an ETF will vary either side of its distribution date. Similar to individual shares, the price of an ETF may rise before the distribution date (cum-distribution) and fall after, as it will then be trading without the value of the distribution payment (ex-distribution).
For example, if the ETF was trading at $80 and has signalled a distribution of $0.50 per unit, it will fall to $79.50 ex-distribution.
Are ETFs considered tax-efficient?
It's worth noting that some ETFs may be more tax efficient than others. For example, ETFs that track a broadly diversified index will generally have a low portfolio turnover which can help keep realised capital gains to a minimum, compared to an actively traded, high turnover portfolio.
What ETFs are best for generating income?
For those looking to focus on income rather than capital growth, there is a range of high-yield ETFs on the market today that may be suitable. High-yield ETFs are generally comprised of companies that have higher forecast dividends relative to other exchange-listed companies.
It's worth noting however that as we are in a low-interest and low-yield environment, recent Vanguard research showed that investor portfolios built on a dividend-focused strategy would need to be 100 per cent allocated to equities to meet most income needs. This means greatly elevating portfolio risk and may be unsuitable for many investors, particularly those close to or already in retirement.
Instead, investors might consider adopting a total-returns investment strategy where they focus on both the income and capital growth elements of the portfolio.
1 To elect to reinvest distributions from your Vanguard ETF, please contact Vanguard's nominated share registry Computershare and the Computershare Investor Centre via their website or call 1300 757 905.