Exchange-traded funds offer the diversification of mutual funds with the trading ease of common stocks. ETFs trade in the markets like shares of common stock. The investments differ from mutual funds in that trades are not held until after the markets close to be executed and settled. Many ETF shares can be traded immediately during normal market hours and through some brokerages after hours. The diversification benefit associated with broad mutual funds can also be had in an ETF. In addition, some exchange-traded funds pay dividends.
As ETF investments grow in popularity, the variety available to investors also grows and diversifies. Funds available on the market include ETF companies that invest in particular sectors of the market, specific country ETFs and index-corresponding ETFs, among others. An exchange-traded fund that invests in commodities may hold derivatives such as futures contracts. In those funds that hold underlying assets that pay dividends or interest, the income is passed on to shareholders in the form of dividends or annual distributions.
Brokers may refer to an ETF as a basket of securities. Whether the ETF pays dividends depends on the contents of the basket. In other words, ETFs pay dividends to shareholders if the assets within the particular fund pay dividends on stocks or earn interest, such as on bonds. Many ETFs that own stocks pay dividends to the investor when the underlying assets, the stocks the fund owns, pays dividends. When the income is distributed depends on the policy of the fund management.
Real estate investment trusts, or REITs, may pay dividends to the investors. If dividend-paying REITs are part of the assets of an ETF, the earnings are passed on to investors in the exchange-traded fund, with the income split accordingly as to the number of ETF shares owned. Operating expenses are subtracted from profits, and operating expense ratios vary. The operating expense ratio is the percentage the fund charges annually for management and administrative costs. On average, ETFs maintain lower expense ratios than comparable mutual funds.
Stock-based ETFs generally pay dividends one to four times annually. Bond-based ETFs pay any forthcoming income through annual distributions, or some may pay monthly dividends on shares of the ETFs the investor owns on a pro rata basis based on the income the underlying bonds pay to the fund. Not all assets in an exchange-traded fund pay regular dividends. In situations where the fund does not earn interest or dividends on the underlying assets, profits for the investor must come through growth-- that is, an increase in market value. However, significant price fluctuations are not the norm for ETFs, and an investor should consider sales commissions when buying and selling shares.