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I want to figure out how ETF works and index ETF particularly. The aspect I can't find explanation for is the following:

Investing into ETF means that I buy ETF stocks which price is based on market demand/proposition as any other share. Correct?

Time from time (I suppose annually) stocks that ETF owns brings the dividend. Do ETF participants get some cash for this?

I'm quite new in investing so I will appreciate for the links and books to understand these aspect better as it's not easy to find the right one among thousands of same articles that rather attracts people to the website and have quite same content.

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    For your first question, read the answer to this question: Understanding how an ETF works
    – Flux
    Oct 29, 2020 at 10:13
  • Welcome new user. Just to add clarity, there are totally different types of ETFs which work completely differently - just as you ask.
    – Fattie
    Oct 29, 2020 at 17:42

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Stock dividends are never paid directly to ETF holders. The ETF will collect the dividends in cash and either reinvest them in the stocks necessary to best track the target allocation of stocks (e.g. an index for an index ETF), or distribute some or all of that cash periodically to investors. They are not required to pass on all dividends or to pass them on as they are received - it's just a decision that the ETF manager makes as to how to deal with cash funds. Most equity ETF pay an annual dividend near the end of the year. Bond ETFs typically pay monthly dividends (since the goal is more often income than growth)

Note also that dividends (for stocks as well as ETFs) have zero effect from a wealth standpoint. If an ETF pays a $1 per unit dividend, then after the payout it has $1 per unit fewer assets and thus the price per unit goes down by $1. So if you own $100 of an ETF before the dividend, after the dividend you'll have $99 of the ETF and $1 in cash. If you choose to reinvest the dividend, you'll still have $100 of the ETF, just in a different proportion of units and price.

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    Your final sentence isn’t quite true, because of tax. The $1 you receive as an ETF dividend will be taxable, so you won’t have all of it available to reinvest.
    – Mike Scott
    Oct 29, 2020 at 17:25
  • In US (which is a big market but not the only one) ETFs, like traditional (book-issue) funds, must distribute substantially all dividend income net of operating expense or else they lose subchapter M tax treatment, which makes them uncompetitive. They can elect a 2-month lag and all I've looked at do -- i.e. in 2020-12 they distribute dividends received 2019-11 through 2020-10 -- but that doesn't change things significantly.
    – dave_thompson_085
    Oct 30, 2020 at 3:36
  • @MikeScott True, but the tax from the dividend is offset by a capital loss in the value of the ETF. So it's not a huge difference (other then timing) and only if those are taxed at different rates. But my main point was that dividends are not "free money".
    – D Stanley
    Oct 30, 2020 at 16:55
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There are two different kinds of ETFs, and they handle dividends differently. Distributing ETFs pay the dividends to the ETF investors, while accumulating ETFs reinvest them which results in an increase in the value of the ETF shares.

While it’s true that ETF prices are entirely dependent on supply and demand, in practice they will always track the market value of the underlying assets very closely, because arbitrageurs are always looking for asset price discrepancies to exploit, and will buy if the market price drops below the asset value, and sell if it rises above.

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