Asked by Anonymous
Asked on 23 Dec 2019
Do they provide compound interest? if not then what's the appeal of ETFs?
If one stays invested in ETFs for the long term, with capital gains and dividends if any over time, this investment will give you compounding returns on an annual basis.
Most ETFs consist of a mixture of stocks and/or other asset classes, so the main appeal is diversification from the mixture.
If you receive the dividends as cash and do not reinvest, then it does not compound. If you do, then it does. For example, IWDA actually auto reinvests your dividends for you. Counters such as STI ETF do not. But you would have to manually reinvest your dividends by buying more of the stock (more fees btw).
The appeal of ETFs would be to give you a basket of top stocks (subjective) just by buying a single stock. It works for individuals who are looking for a "one-stop diversified solution for the long term".
That said, true compounding lies in a business who is growing their business every single year - the compounding will reflect in their share price!
You can reinvest your dividends back to your ETF but you have to do it manually, I don't think ETFs under RSPs offer this service
Top Contributor (Jan)
If you reinvest, then yes you are compounding your investment.
If you receive dividend and do not reinvest, then the compounding effect is reduced alot.
Etfs appeal is they offer diversification by allowing you to be invested in multiple companies by buying just 1 counter.
They did not compound interest but tend to pay out dividends annually
Only accumulating share class ETFs that reinvest dividends automatically. If not, you might need to invest via Robo-advisors which help to automate your reinvestment of dividends
Top Contributor (Jan)
I believe you mean do ETFs reinvest dividends. An investment doesn't pay interest. They pay dividends or coupons. And you need to reinvest them to have compounded growth.
So yes, I believe there are accumulating share class ETFs that reinvest dividends automatically. But I hear they are less popular than the usual distributing ones that pay out dividends.