The Inner-Workings of Dividend ETFs

Income seeking investors love dividends, and exchange traded funds (ETF) that pay these out can be an investors best friend. Sometimes the dividend can fluctuate, creating some confusion for investors. 

An ETF that owns stocks will collect the dividends based on the number of shares of the underlying companies it owns over the course of time, explains Michael Rawson for Morningstar. These dividends collect, and then get paid out to shareholders, often monthly or, more commonly, quarterly.

Other dividend facts Rawson notes:

• Dividend yield is  represented by the sum of all dividends paid by the fund over the past 12 months divided by the previous month-end net asset value.

• When researching a dividend yield, there are two numbers that come up, an average dividend yield and a dividend yield.  The bulk of the difference between the fund's dividend yield and the weighted average dividend yield on the underlying stocks in the portfolio is calculated, which is deducted from dividends before they are paid out to shareholders.

• In order to receive a dividend, you must be the registered owner of the fund by the record date. ETF trades take three days to settle, so you need to buy the fund in advance of the record date in order to receive the next dividend. 

• Caution, however: you might think it's a great idea to buy a fund right before the ex-date, so as to earn an extra dividend, but that isn't quite how it works. The NAV of the fund will adjust downward, so any gain you get from receiving an extra dividend will be offset by a decline in the NAV, at least in markets that are operating normally.

Tisha Guerrero contributed to this article.