The Demented Dividend Guru

"He's demented!"

That's Charlie Munger's opinion of academic Jeremy Siegel. But we'll soon get to see just how demented the Wizard of Wharton actually is.

Put theory into practice
Siegel has signed on as a consultant and board member at WisdomTree, a new money management company with 20 exchange-traded funds (ETFs) that combine two of Siegel's favorite investment strategies: indexing and dividends. Siegel demonstrated in his recent book, The Future for Investors, that the 100 highest-yielding stocks of the S&P 500 outperformed the broader index by more than three percentage points annually from 1957 to 2003.

Now, with WisdomTree's offerings, we'll find out whether this strategy can work going forward.

The guinea pig
The WisdomTree Dividend Top 100 Fund is one of the new Siegel-blessed ETFs. It's made up of the 100 highest-yielding firms among the 300 largest companies by market cap in WisdomTree's Dividend Index. But unlike conventional indices, the WisdomTree fund is (a la Siegel) roughly weighted by yield, rather than by market cap. To show you what that looks like, here are some of the fund's holdings and their weightings (rebalanced annually):

We've long promoted the importance of dividends here at The Motley Fool. I've called dividend payers good stocks to buy now, and we agree with Siegel that dividends can save you from losses while helping you beat the market.

Build a custom dividend portfolio
However, dividend investing isn't necessarily low risk. The Top 100 Fund, for example, has a significant position in Bristol-Myers -- a company that faces an uncertain future. Indeed, one of the reasons why a stock may have a high yield is that investors are wary of it and the price has dropped.

In other words, in an index like this, you take the good with the bad.

The Foolish bottom line
Nevertheless, dividend investing can be a bona fide way to beat the market with less volatility and muted risk of total capital loss. Therefore, I recommend that Fools not only take a look at the WisdomTree offerings, but also at the iShares Dow Jones Select Dividend Index, as well as our own Motley Fool Income Investor service.

At Income Investor, James Early recommends two specific dividend payers each month and can help you build a portfolio of payers that fits your timeline and risk tolerance better than an index can. The current picks yield more than 4% on average, and the entire portfolio is beating the S&P 500 by four percentage points (as Siegel predicts solid high yielders should). You can click here to try the service free for 30 days and determine whether -- like our thousands of members -- it's the right dividend option for you.

This article was originally published on July 12, 2006. It has been updated.

Tim Hanson does not own shares of any company mentioned in this article. No Fool is too cool for disclosure.