If investing in index ETFs, what happens to all the dividends? If they are reinvested, shouldn't they give higher returns than the index every year? (And not just track the index)? - Seedly
 

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Asked by Anonymous

Asked on 02 Mar 2019

If investing in index ETFs, what happens to all the dividends? If they are reinvested, shouldn't they give higher returns than the index every year? (And not just track the index)?

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ぃ杰
ぃ杰
Level 2. Rookie
Updated on 07 Jun 2019

Nicholes Wong: But if the dividends are 4% every year, where does the 4% go? Wouldn't that be a huge loss compared to buying the stock itself (esp when compounded over many years)?

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Gabriel Tham
Gabriel Tham

on 04 Mar 2019

They either distribute the dividends back or reinvest.

Well they get affected by tracking errors and ETFs management fees. Hence, you might see your ETFs giving slightly lower returns than the index itself. Just make sure the ETFs you chose have good tracking error and low management fees. It also takes time for them to rebalance the allocation.

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Hao Yu
Hao Yu, Advisory Specialist at MoneyOwl
Level 3. Wonderkid
Updated on 07 Jun 2019

All the answers provided are key reasons that contribute to the lower performance of Index ETF to the Index it’s tracking.

Another reason is because the measurement of performance of Index ETF and Index is by time-weighted return. This form of measurement does not take into account the effect of reinvestment of dividends. Thus, when coupled with the effects of fees etc, Index etf underperform.

However, in reality, you maybe performing better than Index because you are holding more units of the Index etf and this compounds your returns over time.

For example: (exclude fee)

index started at $1

Index returns 10% + 2% dividend

index ends at $1.10

Index ETF started at $1 - you invest $100, 100 units

Index ETF returns 10% + 2% dividend

index etf price $1.10

your holdings = $112.20 $1.10 at 102.2 units.

You will notice that both Index and Index etf will have annual return of 10% which is the figure that they will report. However notice that as an individual, you’re better off with the extra 2.2 units and your return is actually 12.2%. This is just a simple illustration and in reality it is not so clear cut with all the fees involved.

Therefore, when investing always track your own investment using money weighted return (XIRR) and not rely on the fundhouses return.

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Kishor Bhagwat
Kishor Bhagwat

on 05 Mar 2019

Err...TWR is designed to ignore money flows, whether it is dividends or capital injections. It has nothing to do with the difference in the ETF tracking error. The tracking error comes from fund managers having to react to changes in the index component weightings. If you have a synthetic swap based ETF, it can track the index almost perfectly because there isnt actually buying/selling of the underlying components.
Kishor Bhagwat
Kishor Bhagwat
Level 4. Prodigy
Updated on 07 Jun 2019

Is this a trick question??!! The index itself is either a Net Return Index(dividends paid out) or Total Return Index(dividends reinvested). So your ETF will track the relevant index...and there will be a tracking error associated with it. All this information is mentioned in the fact sheet of the etf.

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Luke Ho
Luke Ho

on 05 Mar 2019

I think he genuinely didn't know man..
Gabriel Tham
Gabriel Tham, Kenichi Tag Team Member at Tag Team
Level 8. Wizard
Updated on 07 Jun 2019

A very good comparison here is VWRD and IWDA. Both are world index ETF.

VWRD distributes back the dividends while IWDA automatically reinvests the dividends.

If you bought both, you will notice IWDA has more capital gains that IWDA.

But why does the ETF not beat the market?

Well, thats because ETFs also has fees involved. Although the fees are much lower than unit trusts, it does still affect the performance. However, an ETF that does reinvesting will track more closely than an ETF that distributes dividends because of compounding.

I don't think you can find a market beating ETF.

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Kishor Bhagwat
Kishor Bhagwat

Updated on 05 Mar 2019

Hi Gabriel, VWRD and IWDA are actually quite different. VWRD inclides Emerging Markets, IWDA doesnt, so you cannot really compare their performance. Secondly, Distribution policy of the ETF is a different attribute than the benchmark index type it is tracking. FTSE All world is a TR index, and I think MSCI is a NR index. A passive ETF is dedigned to track its benchmark, not underperform or beat its benchmark. How the fund manager does his job tracking it is important. It has nothing to do with dividends. Yes fees can make a difference, but ETFs employ different strategies to overcome that..some also lend securities to offset fees. All in all, the tracking error ends up being really small. Lastly, you can look for Active ETFs if you want to beat an index.
Gabriel Tham
Gabriel Tham

on 05 Mar 2019

Well, yea thanks for pointing out! But I can't find the mirror image etf for them where one distributes and accumulates....
Yixiong Chang
Yixiong Chang
Level 5. Genius
Updated on 04 Mar 2019

It depends on each ETF's policy. Alot ETFs pays out dividend as well, but on a fixed schedule. For STI etf like the spdr and NikkoAM sti etf, they pay out dividend semi annually. Some might have DRIP dividend reinvestment program, which the dividends is used to purchase more units of the ETF instead.

Most index u see are price-level index. There are also total return index version of each index that assumes reinvestment of dividend.

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AC
Andrew C
Level 1. Freshie
Answered on 09 Mar 2019

Oic, so the index ETF should over time either:

  1. Pay u some dividends
  2. Give u more ETF units

?

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