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 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 April 1 and a payment date of April 8.
This means any investor who owned VCN on April 1 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, April 1, but sold it on Wednesday the 3rd, the trade would settle on Friday the 5th, and you would still receive the dividend on the following Monday.
So let’s consider how things would work if you had just recently bought some shares in VCN on Friday, March 29. You would see the shares of VCN in your account on April 1, but your trade would not settle until Tuesday the 2nd. So you would not receive the next dividend. For this reason, the business day before the record date is known as the ex-dividend date (in this context, ex means without).
You might be wondering whether there is an opportunity to profit here by purchasing shares on the day before the ex-dividend date (Thursday, March 28 in this example), 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.
Swapping dividends for capital gains
In a non-registered account, however, there can be tax implications to the timing of an ETF trade.
Say you hold 1,000 shares of a Canadian equity ETF that announces a dividend of $0.50 per share with a record date of Thursday, May 9. The ex-dividend date is the previous day, Wednesday the 8th, so you should expect the ETF’s price to fall by about $0.50 on that date.
Now let’s assume your ETF shares have appreciated by $2,000 as of Tuesday, May 7. If you sell them on that day (just before the ex-dividend date), you would realize a capital gain of $2,000. However, if you sold the shares the following day, on the ex-dividend date, the share price is expected to fall by $0.50, so your realized capital gain would be only $1,500. You would also receive $500 in dividends, so the total proceeds are the same in both cases.
As we’ve said, in a registered account these are equivalent. But dividends and capital gains are taxed at different rates. If you’re in a low tax bracket (where Canadian dividends are taxed more favourably), you’re better off collecting the dividend. If you’re in a high tax bracket, you’ll likely pay less tax if you take the larger capital gain.
The opposite is true if you’re buying an ETF immediately before it pays a dividend. In our example above, if you buy the shares in a taxable account the day before the ex-dividend date, you will receive a taxable cash dividend almost immediately. It might be better to buy the next day, when the price should be lower and you won’t receive the taxable dividend (even though you’d incur a larger capital gain when you sell your shares in the future).
I need to stress that these explanations are theoretical: markets move quickly in the real world, and by waiting a day or two to make a purchase, the normal fluctuations of the market can easily work against you. For example, you might expect an ETF’s price to fall $0.50 on its ex-dividend date because that is the amount of the distribution, but normal market movements can cause the shares to go up or down by much more than that. So don’t try to be too clever here: the point is simply to understand the issues you may encounter when trading ETFs near their dividend dates.
Hi, Dan, what is the best etf for investing in all Can. banks? Thx. Dick
Hey Dan I am switching fro VXC to VEQT in my RRSP. I just love the one fund simplicity! The ex-dividend date of VXC is June 27 and the pay date is July 8. If I sell VXC now, I avoid the dividend and the risk of DRIPing and getting stuck with a handful of VXC shares. But by selling now, am I “losing” money by not waiting to get the dividend? Or is it relatively equal if I still sell it now? Thanks!
Bryan, if doesn’t matter when you sell. If you sell before the ex-div date, the accumulated dividends are included in the NAV and the price you receive. If you sell ex-div or later, the NAV is lower but you receive the dividend in cash or shares/cash in a DRIP.
@CCP
I noticed in my BMO investorline account my TDB661 was switched to the e-series TDB902 mid June without any request from me, I had no clue e-series was even available in BMO Investorline and the exchange was done without advising me is strange. The adjusted cost base is the same.
Do you have any information about able to buy e-series in Investorline or have heard of other folks TD investor series index funds being exchanged for e-series? I’m kind of annoyed i was not sent any message from BMO about the switch.
@Jake: Thanks for letting me know about this. This might be a new policy from TD: I am investigating and will report back when I know more.
@Jake: I reached out to TD and received the following response: “Clients holding TD funds in discount brokerage accounts (within TD and externally) had received a letter in May advising them that TD Asset Management will complete a one-time conversion of I-series, P-series and applicable A-series units on June 15th to lower cost D-series or e-Series to help the client save on management fees. The funds that currently don’t come in D-series would have been switched to the corresponding e-Series.”
I think TD deserves from credit for this. As you may know, there has long been controversy surrounding the practice of discount brokerages receiving trailer fees (which are embedded in A-Series and TD’s I-Series funds), as these are supposed to be paid to advisors for servicing the client. Discount brokerages, by definition, provide no advice, yet they still collecting this fee simply for holding the fund. The regulators have failed to crack down on this practice, but TD has proactively taken steps to ensure it doesn’t happen with their funds.
Hello Dan,
I’ve been looking into setting up a simpler and more passive approach to using your model portfolio with Questrade. There is a new to me service on Questrade called “Passiv” which allows for automatic reballancing accross multple accounts, automatic buying and selling to maintain a pre-defined target, and automatic purchase of the correct numbers of shares for multiple holdings in multiple accounts. Passiv is linked to Questrade’s service with an API which allows it to see when cash appears in any of a user’s accounts and can command questrade to execute trades.
I checked it out and it seems to only give calculations for free, but all the automated stuff costs $40/year. Could you do an article on this service? Do you think its worth-it for someone that wants to do continuous contributions from their work and have them auto-invested? Anyways, would love to get your take on this. Your website has been my top resource, thank you so much for all your hard work.
PS: Not sure if its allowed, but its easily searchable on questrade’s site. Here’s the link for Passiv that explains what it is.
https://questrade-support.secure.force.com/mylearning/view/h/Investing/Getting%20started%20with%20Passiv
@Daniel: Thanks for your email. I can see a lot of value in this service for someone whose portfolio has many moving parts. But the appearance of “one-fund” asset allocation ETFs has reduced the need somewhat. These funds eliminate the need to rebalance, so all you would need to do is log in once a month or so to invest your contribution, which is free at Questrade anyway.
Dan, I had an unusual trading experience (for me) that I wanted to run by you. You and others have counseled, when buying a security, to use the limit option and set the price at the upper end, or even over, the ask amount, in order to ensure the trade goes through quickly and easily. The assumption I’ve always worked under is that trades will go through at the lowest possible price, not necessarily at the limit you set. That has frequently happened in the past.
In this case, I was buying 600 units of ZLD. I set the limit at the high end of the bid/ask spread, which was $25.02, even though the lower end was $24.92. The trade immediately went through at the limit, $25.02. Then it showed up in my account as priced at $24.92, with no change showing in the change column.
I phoned Royal Direct and asked why the trade had been executed at the upper limit despite the current price being 10 cents lower, and after some investigation I was told that the market makers had sold me the security at the limit I had set.
So the trade did not go through at the best possible price at all. And that trade didn’t cost me the $9.95 trade fee, it cost me $69.95.
And the security still sits in my account showing no change. According to that, I haven’t lost any money. But I’m still out $60.
Lesson learned I guess. I won’t be setting my buys at the upper limit of the spread again. I’m curious about whether you think this is entirely normal procedure and I have no reason to be surprised, or what. Thanks.
@Trevor: Based on what you have described, nothing went wrong here. You entered a limit order for $25.02 and the order was filled at that price, which is exactly what should happen. When your brokerage displays the current value of your holdings, they typically use the bid price, not the ask. This makes sense, because if you were to sell your holding now, you should expect to receive the bid price. The “loss” you’ve suffered is simply the transaction cost you would pay any time you bought and then immediately sold a security with a 10-cent bid-ask spread.
What could you have done differently here? Had you placed a limit order at anything less than $25.02 the order would have gone unfilled.
My ETFs and stocks are set up for DRIP. I sold all my stocks in a company and a few days later, a single share popped up in my account. Apparently, I received dividends some time after selling and these were reinvested, leaving me with a single stock to sell in order to completely rid myself of that stock. I’d never heard of that happening before…
Would it make sense to sell before ex-div date so as to avoid foreign withholding tax? Obviously, I’d rebuy the day after at the lower price.
@Vince: It never makes to try to get clever like this. If you are planning to buy a new holding or permanently sell one, then it may make sense to place the trade on a date that is more favourable from a tax perspective. But trading in and out is a bad idea. Market movements can easily ruin your plans, i.e. you can never assume that the price will be lower on the day you repurchase.