Dividend Drag

What Is Dividend Drag?

Dividend drag is the negative effect of the dividend structure of a unit investment trust (UIT), or exchange-traded funds (ETF) without an automatic reinvestment program, by which investors can't quickly reinvest their dividends. There is a delay between when dividends are issued and when those dividends can be reinvested. In the event that the share price is rising, this delay can mean the dividends are reinvested at a higher price than if there was no lag. With mutual funds, there is no lag or drag.

Understanding Dividend Drag

Dividend drag influences shareholders assuming they choose to reinvest the dividend themselves, or on the other hand in the event that they teach their broker to make it happen.

The structure of UITs postpones dividend payments for a really long time, and in a rising market the share price to reinvest at is continually expanding. Without an automatic dividend reinvestment (DRIP) option for shareholders, it might require seven days for the money to be reinvested. Meanwhile, the price of the shares will have increased, and a similar amount of money will buy less shares than if it had been quickly reinvested.

In a declining market, dividend drag isn't an issue essentially. Because the price is falling, the lag might bring about having the option to buy more shares with the dividend.

Dividend lag exists because UITs have more than one participant. With a mutual fund, the mutual fund company can take your dividend and quickly put it back into their fund. They control the cycle. With a UIT, the pooled assets are normally held with an investment bank, so the dividend is going through an extra set of hands. This increases the time it takes to receive as well as reinvest the dividend.

A few brokers offer dividend reinvestment plans, while others don't. Regardless of whether the plan is offered, the structure of the ETF will decide whether there is a lag in getting the dividend reinvested or not.

ETFs Without Dividend Drag

Dividend drag is a feature specific to UITs. Today, most ETFs are open-end management investment companies. Like UITs, management investment companies require several days to get dividends into the pockets of shareholders. Not at all like UITs, management investment companies can choose to reinvest profits as opposed to giving a cash dividend, consequently dispensing with dividend drag.

Management investment companies' operating costs are higher than those of UITs, however their mutual fund-like structure takes into consideration greater flexibility. Investors ought to assess the quality of an investment with regards to their personal investment philosophy and unique life situation.

Does Dividend Drag Matter?

While dividend drag is enough for certain investors to avoid UITs totally, they stay a famous investment product. Probably the biggest ETFs trading today are UITs, as a matter of fact. For some investors, dividend drag doesn't count for a lot. Some find the net effect of dividend drag, while legitimate and measurable, still too small to issue, especially taking into account the wide range of various factors in assessing a fund, for example, index tracking, exposure, operating costs, and tax efficiency. Additionally, the drag is unfavorable in quickly rising markets, however can be favorable in falling markets.

Certifiable Example of Dividend Drag

The SPDR S&P 500 (SPY) ETF Trust is a unit trust. Envision a dividend is paid of $1.56 per share. A unit holder possesses 300 shares, and thusly will receive $468 in dividends on the dividend payment date. Accept that the share price on that day is $240.

The dividends would buy an extra 1.95 shares or units. Presently accept that it requires several days to handle the dividend and get it reinvested. The share price of SPY has climbed to $245. The $468 in dividends presently just buys 1.91 units.

While this might seem like a small difference, in the event that it happens on numerous occasions, this will reduce performance. In this case, the investor paid 2% more for the shares than they would have without the delay.

To offset this, the lag will sometimes bring about a better price.

Features

• Dividend drag reduces performance when the share price is rising because dividends aren't reinvested right away. The delay means the dividends reinvest at a higher price than if there was no lag.
• Many brokers offer a dividend reinvestment plan (DRIP), yet how rapidly those dividends are reinvested depends on the structure of the ETF.
• Dividend drag influences unit trusts because of how they are structured. The dividends go through an extra set of hands, and that means it requires investment for the dividends to get reinvested.
• Mutual funds don't have dividend drag.