The Facts And Features Of Earning Dividends From Index Funds
Do you get dividends from index funds? That’s today’s question.
And here is today’s answer…
Do Index Funds Pay Dividends?
Yes. Index funds pay dividends. Because regulations require them to do so in most cases.
As a result, index funds pay out any interest or dividends earned by the individual investments in the fund’s portfolio. After reducing them by the fund’s expenses.
However, the amount, timing, and tax implications of dividends paid will depend on the index fund you hold. In addition to your specific tax situation.
For example, in an extreme case, an index fund of stocks from high-growth companies. Where management reinvests all profits back into their businesses. Then, the index fund holding these stocks may pay no dividends at all.
So, let’s further explore the different aspects of dividends paid by index funds.
Disclosure: At no cost to you, I may get commissions for purchases made through links in this post.
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What Is An Index Fund?
Let’s start with the basics.
Here is how Investor.gov defines an index fund…
First of all, an index fund is a type of mutual fund or exchange-traded fund (ETF) that seeks to track the returns of a market index.
Furthermore, a market index measures the performance of a basket of securities. Usually, stocks or bonds.
Finally, the securities held by the index fund are meant to represent a sector of a stock market. Or, that of an economy.
Now, to put it in my own words. An index fund is just a portfolio of stocks or bonds.
The securities are combined for the investor into a single holding. Making investment diversification much quicker and easier.
Mutual Funds Versus ETFs
In recent years, ETFs have gained popularity over traditional mutual funds that track an index. However, the 2 are very similar.
Furthermore, as it relates to their dividend payments. There isn’t much of a difference. Thus, the following information is relevant to either.
Why Do Index Funds Pay Dividends?
Index funds pay dividends because they are required to do so. When the underlying securities make dividend income payments or interest payments to the fund.
Conversely, when an index fund holds securities that do not pay dividends. For example, high growth stocks that have no profits. Or, where all profits are reinvested back into their businesses. The index fund will not have dividends to pay its shareholders.
Thus, the dividends are a pass-through. Coming from the companies that pay them. To the index fund. And finally, to the index fund’s investors.
How Are Index Fund Dividends Paid?
Next, how do index funds pay dividends? Well, dividends from an index fund are received in one of two ways.
The first way is cash. Deposited into your brokerage account where you hold the fund.
The second way is dividend reinvestment. This happens by instructing your broker to pay the dividend with additional shares of the fund that paid the dividend.
When Are Index Fund Dividends Paid?
Dividends from index funds usually follow one of three different dividend payment patterns. Specifically, monthly, quarterly, or annually.
What I have found with my investments, is stock index funds pay quarterly. While index funds that hold bonds pay monthly.
Index Fund Dividends And Fees
Dividends from index funds are paid net of fees.
In other words, the fund subtracts its management fee from the dividends. Then distributes what is left over to the shareholders.
And here’s the great thing about index funds. They have very low fees. So, fundholders receive most of the dividends.
Why are index funds so inexpensive. Because they track an index through automation.
So, there is no need to pay a fund manager or team to make investment decisions.
Are Dividends From Index Funds Taxable?
Whether you choose to make your dividends in cash. Or, instruct your broker to reinvest them. They are considered taxable income.
Everyone’s tax situation is different. So, I recommend you talk to your tax advisor for advice about your taxes.
However, I will say this: dividends are classified in 1 of 2 ways for tax purposes.
First, they can be considered qualified dividends.
And I find. most dividends from U.S-based stocks are qualified dividends. This means the dividends are taxed at a lower tax rate.
To be eligible, certain requirements must be met by the dividend payer. And the investor must hold the stock for a minimum time.
Second, there are non-qualified dividends. They are subject to higher ordinary income tax rates. Because of this, sometimes these dividends are called ordinary dividends.
You can avoid or defer taxes on dividends by holding your investments in an Individual Retirement Account (IRA). There are many excellent places to open and hold an IRA account if you want to save for retirement.
So, now that you know that index funds pay dividends. And the details about when and how dividends are received.
Let’s take a look at 3 index funds that pay dividends. Each is an ETF…
3 Examples Of ETFs That Pay Dividends
First, there are a lot of excellent index funds that pay dividends.
Second, by allocating your investment assets to the following 3 ETFs, you will have a nice, diversified dividend portfolio.
Third, I have provided a link for each fund’s more detailed review. For anyone that wants to learn more.
Vanguard High Dividend Yield ETF (VYM)
VYM mainly holds U.S.-based dividend stocks of companies that pay higher dividend yields.
Stocks in the portfolio often yield between 2% and 4%. Plus many of the portfolio companies increase their dividends regularly.
For example, you will see stocks like Johnson & Johnson (JNJ), PepsiCo (PEP), and Procter & Gamble (PG) as core holdings in this ETF.
Also, the fund pays dividends quarterly. And they are mostly classified as qualified for tax purposes.
From my perspective, VYM is an excellent core dividend stock ETF. Capable of being the centerpiece of a dividend ETF portfolio.
You can learn more about VYM here.
Vanguard International High Dividend Yield ETF (VYMI)
VYMI focuses on non-U.S.-based dividend stocks with above-average dividend yields. The fund is an excellent way to diversify an investment portfolio.
Having nearly 1,000 stocks that pay dividends from across the globe. It represents a great list of international companies.
For example, you will see names like Nestle, Toyota, and Royal Dutch Shell.
Finally, similar to its U.S. counterpart VYM, this index fund also pays dividends quarterly. And the payouts are typically a mix of qualified and non-qualified dividends.
You can learn more about the VYMI fund here.
Vanguard Total Bond Market Index Fund (BND)
Unlike the prior two index funds, BND holds bonds. Specifically, intermediate-term investment-grade bonds traded in the United States.
Depending on your age and risk tolerance, it’s a good idea to hold some bonds. Not only for the income they provide. But also for the diversification benefits.
Because many times bonds will stabilize a portfolio. When the stock market is going up and down.
From a payment perspective, BND pays its dividends monthly. However, the dividends are mainly considered ordinary income for tax purposes.
You can get the details about BND here.
Now that you know about some excellent index funds that pay dividends. It raises another important question…
Should You Invest in Dividend Stocks Or Index Funds?
Many investors own both individual stocks and index funds. While some investors stick to one or the other.
There is no right or wrong answer.
However, I can offer some guidelines to consider when trying to decide between dividend stocks or index funds…
Index funds are typically better for an investor who prefers a passive approach, desires a high level of diversification, and can accept earning investment returns that match the stock market indexes.
On the other hand, for those who like picking dividends stocks, monitoring a dividend portfolio, and having more control of their investments, then stocks are a good choice.
Furthermore, to assist with dividend stock selection for my dividend portfolio. I use the Simply Investing Report & Analysis Platform.
Okay. That’s our answer to today’s question.
Allow me to wrap up with a few concluding thoughts…
Do Index Funds Pay Dividends?
Can you get dividends from index funds? In short, yes. And to recap…
Many index funds pay dividends on a regular and recurring basis. Assuming they hold dividend stocks or interest-bearing securities.
The dividends are paid net of fund expenses. Furthermore, your dividend payments can be taken in cash or reinvested automatically back into the holding that paid them.
Three top index funds that pay dividends include:
- (VYM) Vanguard High Dividend Yield ETF
- (VYMI) Vanguard International High Dividend Yield ETF
- (BND) Vanguard Total Bond Market Index Fund
Finally, it’s up to you to decide between individual stocks or index funds. Either is fine and the decision mainly depends on your investment expertise and personal preferences as an investor.
Ready for more? If yes, see our many excellent guides to…
Dividend Stocks and Dividend Investing
Author Bio: Tom Scott founded the consulting and coaching firm Dividends Diversify, LLC. He leverages his expertise and decades of experience in goal setting, relocation assistance, and investing for long-term wealth to help clients reach their full potential.
I own all three of the index funds mentioned in today’s article.
Your question answered…