DIVIDEND DRAG

A disadvantage of the dividend structure of unit trust exchange-traded funds (ETFs) that results from SEC rules that stipulate that passively managed ETFs cannot reinvest dividends back into the portfolio. ETFs must instead accumulate the dividends in cash and pay them to holders at periodic intervals. During periods of rising markets, the dividends would be better served being reinvested in securities rather than held in cash. This leads the ETF to lag a portfolio that would be able to reinvest.

This is a problem in a rising market, but the same SEC rule is beneficial in a declining market. Either way, this has been a problem in ETF circles, which have been pushing for the SEC to change the rules. If this happens, dividend drag will essentially disappear.