Trading ETFs Near Dividend Dates

Trading ETFs Near Dividend Dates

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In my most recent podcast, I addressed an excellent question from Philip, who asked, “Are there days when ETF investors should avoid trading?”

Philip’s question has nothing to do with trying to time the market. He simply wants to know whether there might be days when you should not buy or sell ETFs close to the dates when distributions (dividends or interest payments) are made. And the answer to that question is—maybe.

Let’s begin with a reminder that when you buy or sell shares of an ETF, the trade settles two business days later (weekends and holidays are excluded). In the industry, this is known as T+2 settlement. For example, say you buy 500 shares of an ETF at $20 each on Monday. Assuming no holidays, the trade settles on Wednesday, so you do not necessarily need to have the $10,000 in your account until that day. (In practice, some brokerages do not allow you to place a trade if you have insufficient cash in the account on the trade date.)

If you sold those 500 shares for $20 each on Monday, the cash balance in your account might read $10,000 immediately, but your brokerage almost certainly will not allow you to withdraw that cash until after the trade settles on Wednesday.

How settlement dates affect dividends

Now let’s consider how settlement dates affect the payment of dividends. When an ETF announces a dividend (or, in the case of a bond ETF, an interest payment), it will declare a record date and a payment date. To use a real-world example, the most recent dividend paid by the Vanguard FTSE Canada All Cap Index ETF (VCN) was $0.24 per share, with a record date of March 2 and a payment date of March 9.

This means any investor who owned VCN on March 2 would receive the dividend one week later, and this would be true even if he or she sold the holding during the intervening days. If you owned the ETF on Monday, March 2, but sold it on Wednesday the 4th, the trade would settle on Friday the 6th, and you would still receive the dividend on the following Monday.

You might be wondering whether there is an opportunity to profit here by purchasing shares on the day before the ex-dividend date and then selling them the next day? That would entitle you to the dividend and—assuming you could sell your shares for roughly the same amount you paid—you would be collecting that income with very little risk.

Well, as you can imagine, if it were that easy, every hedge fund would have an algorithm programmed to harvest free dividends in this way. The reason this doesn’t work is that on the ex-dividend date, the share price of the ETF will fall by an amount roughly equal to that of the expected dividend. This makes logical sense, because a share of an ETF is more valuable if it comes with the promise of the dividend, and less valuable if the dividend is not included. The market is efficient enough to recognize this, so you can’t make a risk-free profit.

All of this means that if you’re buying or selling ETFs close to the dividend record date in an RRSP or TFSA, there is no specifically good or bad time to place your trade. Either you’ll pay less for the shares and forfeit the dividend, or you’ll pay more and receive the distribution. There is no theoretical advantage or disadvantage either way.