DIVIDEND FUNDS VS
DIVIDEND STOCKS

To invest in dividend-paying instruments, investors can opt for either dividend funds, ETFs or individual stocks. This article will explore what options are available, compare these, and help you to select the best option for your own financial goals.

If you’re considering dividend investing, you can get started in a variety of ways. You might consider buying a single stock with an established track record of paying dividends, or a fund that holds a basket of similar dividend stocks. Both of these instruments offer ways of generating a consistent passive income, and have relative advantages and disadvantages. This article will compare fund dividends to stock dividends to help you to take a better-informed approach to investing in them.

What is a fund dividend?

In a similar way to dividends paid on individual stocks, fund dividends are a way for investment funds to distribute a share of their operating profits to shareholders. These dividends can be in the form of cash or stocks. 

If you own dividend stocks via any type of investment fund, such as a mutual fund or an exchange-traded fund (ETF), the company will pay the dividend to the fund, and the fund will pass the payment on to you. This method of dividend payment is known as a “fund dividend.”

A “fund dividend” reflects that some of the stocks held within an investment fund opt to pay a dividend.

The total gross dividend paid by a fund will be the same as if an investor held the same number and selection of stocks individually. The net dividend will be determined by the tax status of the fund, and the personal circumstances of the investor.

Fund dividends vs stock dividends

Fundamentally, the decision about which approach is best comes down to your individual investment aims, and how much time you can devote to achieving them. However, by assessing some of the differences between fund dividends and stock dividends, investors can hope to make a well-informed decision.

Automatic vs staggered payments

One of the main differences between fund dividends and stock dividends is that stock dividends are automatically paid on the dividend payment date, but dividend payments to fund investors might be staggered. 

This occurs because staggered payments allow the fund manager to streamline the payment and reporting process, by making fewer payments overall. While the total dividend proceeds will be the same as if dividends were paid when they were received, and the underlying share will pay the dividend on the same date, the fund may have stated terms that mean that dividends are paid to investors less frequently.

Date of payment

Another key difference between stock dividends and fund dividends is that unlike individual dividend stocks, funds can be set up to pay dividends to investors over various timeframes, be it monthly, quarterly or annual payments. 

For example, the SPDR S&P 500 ETF, one of the world’s most popular ETFs, pays dividends quarterly. On the third Friday of the last month of any fiscal quarter, the fund managers record all dividends that have been paid since the last reporting date, and generate payments to investors as the quarter ends.

Type of dividend

Funds may also stipulate that when given the option of a cash or stock dividend by a company, investors must always take dividends in one specified form. This typically constitutes an integral part of the fund’s investment mandate, and is highly unlikely to change. Conversely, an investor holding an individual stock that pays dividends with a choice of cash or more stock options can simply opt for their preferred choice of payment on a case-by-case basis.

Costs and practicalities

There are other differences between single stock and fund dividend strategies that extend beyond the mechanics of how dividends are paid. 

For instance, a dividend fund offers additional convenience. With one click, investors can gain exposure to a range of different stocks, rather than having to buy them all individually. Having exposure to multiple positions also factors in a degree of portfolio diversification, which can help to manage risk and reduce vulnerability to volatility.

The trade-off is that a fund manager will charge a fee for their services. If your fund is passive in nature (such as an ETF), it will be designed to track the market, rather than beat it. Typically, this will keep costs relatively low. 

The Vanguard Dividend Appreciation ETF, for instance, seeks to track the performance of the S&P US Dividend Growers Index, which contains large-cap stocks that have a record of increasing their dividends year-on-year. The expense ratio of the VIG ETF is 0.01%, which means that the annual charge on a $10,000 holding would be $1. 

Conversely, if your fund is more actively managed and employs staff tasked with attempting to outperform the market, costs should be expected to be higher.

It is also worth considering what exactly your investment vehicle will do with your dividends. Will it pay them to you directly, or reinvest them automatically? Automatic reinvestment of dividends can help investors to make the most out of the compounding effect. When weighing up the decision between a dividend fund and a dividend stock, this can be an important consideration.

Funds vs stocks — which has the better dividends?

The relative performance of ETFs and individual stocks depends on the underlying holdings — the stocks involved. If you have built a personal portfolio that perfectly matches the positions held in an ETF, then the gross dividend payments will be identical. If you have built a personalised portfolio of stocks that you have researched and believe will outperform, your returns could beat those of an ETF. However, this is not guaranteed, and there is a risk that you post returns lower than the benchmark.

Final thoughts

Dividend stocks offer a way to generate a passive income regardless of whether you hold the stocks individually or as part of a fund. The two approaches have more similarities than differences, with the decision on which approach suits you best likely to come down to how you weigh up the additional convenience of funds against how confident you are that you can create a bespoke portfolio of individual stocks that perform well.

Use the eToro Academy to learn more about dividend investing.

Quiz

FAQs

Why do some companies offer the option of taking a dividend in the form of additional stock?

Stock dividends provide companies with a way of rewarding shareholders without reducing the amount of cash on their balance sheet. The decision on whether this option will be made available to shareholders will be made by the company’s management team and could, for example, signal new business projects being planned that will require capital investment.

How can I track what dividends have been paid?

Whether you hold stocks outright or in a fund, you can track historical and upcoming dividends using a dividend calendar. If you invest in a fund, the manager will provide additional statements and services that will allow you to keep a record of your dividend income.

What is compounding?

Compounding is the process by which periodic income relating to an asset (such as a dividend) is reinvested, and more of the asset is purchased. This can result in a “snowballing” effect, which many investors consider to be the secret of successful investing. While some funds offer investors automatic dividend reinvestment, others will require manual reinvestment or “opting in.” Always check the Terms and Conditions of your investment to understand how to make the most of compounding.