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With the economy struggling, many investors have taken a second look at giving dividend-paying stocks a larger role in their portfolios. In a year in which stock prices have plunged and future prospects for many companies look dire, pinpointing those companies that have enough financial strength to generate cash flow and pay it to shareholders year in and year out can give you some much-needed confidence.

But once you decide that you want to add some dividend stocks to your portfolio, you need to figure out how to do it. Do you want to pick a few companies that look especially promising to you, or would you prefer a simpler approach that gives you immediate exposure to dozens of dividend payers in a single package? Which option you choose can make a big difference in your results.

One-stop dividend shopping
Now that exchange-traded funds have been around for several years, the variety of offerings you can find in the ETF world covers just about every niche you could possibly imagine. If you want, you can find an ETF that buys nearly every stock in the Russell 2000 small-cap index, or make a double-sized bet against a basket of financial stocks that includes Wells Fargo (NYSE: WFC  ) and Goldman Sachs (NYSE: GS  ) .

So it should come as little surprise that you can find an ETF that will give you quick exposure to an array of stocks with healthy dividend payouts. One of the most popular ETFs in the dividend space is the iShares Dow Jones Select Dividend Index ETF (DVY), which holds slightly over $4 billion in assets and owns about 100 different stocks.

How they get picked
The iShares ETF tracks an index established by Dow Jones. To make it into the index, a company has to have sustained or grown its dividends in the past five years while not paying out more than 60% of its earnings per share in dividends (along with having a daily trading volume of over 200,000 shares). Once a stock makes it into the index, the fund does quarterly and annual reviews to determine whether it should remain there.

Unlike many index funds, which often weight their holdings by market capitalization, the iShares fund weights stocks by their dividends. That produces some top holdings that aren't necessarily the household names you're used to seeing:


Share of Fund Assets

Dividend Yield

PNC Financial (NYSE: PNC  )



DTE Energy (NYSE: DTE  )



Pinnacle West (NYSE: PNW  )



FirstEnergy (NYSE: FE  )



Chevron (NYSE: CVX  )



Source: iShares, Yahoo Finance. Information as of Dec. 10.

Pros and cons of funds
Obviously, a fund like the iShares Dividend ETF makes it easy to pick up dividend-paying stocks. Rather than researching numerous companies and buying shares of each separately through your broker, you can make a single purchase of ETF shares and keep things simple.

But there are a few reasons why you might prefer buying individual companies instead of a fund like the iShares Dividend ETF:

  • Fees. The iShares ETF charges 0.4% annually as a management fee. While that's less than a typical actively traded mutual fund, it's more than some index funds.
  • Sector weights. Because of the mechanical way in which Dow Jones selects stocks for its index, the iShares ETF isn't as diversified as you might think. For instance, financial stocks make up a whopping 45% of the fund's assets -- more than three times their sector weight in the S&P 500 overall.
  • Flexibility. With an ETF, when you sell shares, you effectively sell a portion of all of the fund's holdings. If you own individual stocks, however, you get to pick which companies you sell. That lets you make tactical decisions about things like sector allocation, tax-loss harvesting, and risk management at the individual company level much more easily.

Dividend ETFs give you a quick, easy way to own dozens of dividend-paying stocks. Whether they make sense for you, though, depends on whether you value their simplicity over the greater flexibility that comes from managing your own dividend-stock portfolio.

More Foolishness on the power of dividends to help you in tough times:

If you prefer the flexibility that comes from owning individual stocks, take a look at our Motley Fool Income Investor newsletter. Every month, we give you recommendations for promising dividend-paying stocks, along with analysis of past picks and news about current market conditions. Best of all, you can try it out absolutely free with a 30-day trial.

Fool contributor Dan Caplinger loves collecting dividends, but he likes to go with stocks rather than funds whenever possible. He doesn't own shares of the companies mentioned in this article. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy always pays dividends.

Read/Post Comments (2) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 11, 2008, at 5:41 PM, lamontsf wrote:

    How would you compare this ETF with SDY, which I believe follows the S&P aristrocrats index? The expense ratio is roughly the same, but I was curious if there were any reasons to pick one over the other.

  • Report this Comment On December 15, 2008, at 8:55 PM, TMFGalagan wrote:

    Thanks for your comment, lamontsf. I'm planning to look at that as part of a future article.

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