ETF distributions explained

ETFs are a popular investment choice thanks to how easy they are to buy and sell — and how quickly you can potentially build a diversified portfolio with a single purchase. Another reason for their popularity is the ability to earn investment income, as some ETFs also offer regular payouts, called distributions. But not all distributions are the same. Understanding what’s behind those payments can help you better evaluate what you’re really earning.

In this article, we’ll unpack how ETF distributions work, including dividends, interest, capital gains, and return of capital.

ETF distributions are payments to investors, typically — but not always — drawn from what the fund earns through its investments. Most ETFs pay distributions to investors on a monthly, quarterly or annual basis. These payouts may include:

• Dividends: From stocks held in the ETF
• Interest: From bonds, GICs or other fixed income holdings
• Capital gains: From the sale of securities at a profit
• Return of capital (ROC): Read on for more about this

You’ll also see something called distribution yield in the fund’s description, which reflects the ETF’s distributions over the past 12 months expressed as an annualized percentage. Distribution yield is often used to give investors a rough idea of potential income. Note that distribution yield is different from dividend yield, which is based only on the dividend income generated.by the ETF’s holding.

But while yield can be useful, it doesn’t tell the whole story. Before we explain why, let’s show how it’s calculated.

Distribution yield is calculated using a simple formula:

Distribution yield = Past 12 months’ distributions ÷ Current ETF market price

For example, if an ETF currently trades at $20 and has paid $1 in total distributions over the past 12 months:

$1 ÷ $20 = 5% estimated distribution yield

But this number only shows what was paid in the past — and doesn’t tell you what went into that payout either.

A high yield can look appealing, but it’s worth understanding what makes up that yield. Some ETFs maintain high yields by including return of capital (ROC) in their distributions. While this can serve a purpose, it’s not the same as earning income or profit.

Fund managers may use ROC to support consistent distributions without needing to sell long-term holdings they still believe in. In that sense, it can be part of a thoughtful approach to managing the portfolio and delivering a reliable investor experience.

It’s helpful to know that:

• ROC isn’t considered income, so it’s not taxed when received.
• It lowers your adjusted cost base (ACB), which may result in a larger capital gain when you eventually sell the ETF.
• Over time, this may shift when and how much tax you pay — but it doesn’t necessarily reduce your total return.

In a well-managed ETF, return of capital can support tax efficiency and income stability — especially when combined with a long-term performance strategy. The key is simply to understand what’s behind the payout so you can make informed decisions.

ETFs can generate capital gains in two main ways:

1. Within the fund: When the portfolio manager sells a stock or bond in the ETF at a profit, that gain may be distributed to investors.

2. When you sell: If you sell your ETF units for more than you paid, you trigger a capital gain on your own investment.

Both are considered capital gains — but only the first one appears in the ETF’s distributions. The second is based on your personal investment activity.

Sometimes, the amount you receive in cash distributions doesn’t match the taxable amount on your tax slip. That’s because not all distributions are taxed the same way.

If you’re ever unsure how to handle this, especially in a non-registered account, consider reaching out to a tax professional.