If you want to add exchange-traded funds (ETFs) to your portfolio, good for you! These unique instruments, halfway between stocks and mutual funds, make a lot of sense for many people. The iSharesDow Jones Select Dividend Index (AMEX:DVY), for example, has gained an annual average of about 12% over the past three years, and outpaced the S&P 500-tracking SPDRs ETF during that period.

Why dividends?
Dividends have the power to turbocharge your portfolio's performance. Invest in healthy, growing, dividend-paying companies and you can hope for double-barreled profits. You'll receive regular (and usually growing) dividend payments even as your company's stock appreciates. Reinvest those dividends in additional shares of stock, and you can enjoy a lucrative snowball effect.

Motley Fool Champion Funds advisor Shannon Zimmerman recently had this to say about dividends:

Between January 1926 and December 2004, 41% of the S&P 500's total return owed not to the price appreciation of the stocks in the index, but to the dividends its companies paid out. That's right -- a cool 41%. On an annualized basis, that amounts to a difference of 4.4 percentage points. To put it in dollars-and-cents terms, consider this: An investment of $10,000 over that stretch of time would have grown to $1,013,000 without dividends. With dividends kicked in and reinvested, however, that same sum would have been worth a whopping $24,113,000 by the end of the period.

Why ETFs?
ETFs offer investors several advantages over index funds and other mutual funds. For one thing, while many funds have minimum initial investment amounts in the thousands of dollars, you can buy as little as one share of an ETF, which can cost less than $50. Of course, since you buy and sell ETF shares through your brokerage as you would trade shares of stock, you'll be forking over your usual brokerage commission to do so. Paying, say, $20, to buy a $50 share isn't too cost-efficient, so make sure you keep your commission costs around 2% of each trade's value.

Learn more about the pros and cons of ETFs in our ETF Center.

Under the hood
Wondering what exactly is in the iShares Dow Jones Select Dividend Index? Wonder no more. It invests in the 100 (or so) highest-yielding companies in the Dow Jones U.S. Total Market Index. Its top holdings include:

  • Al tria Group (NYSE:MO)
  • Bank of America (NYSE:BAC)
  • Merck (NYSE:MRK)
  • AT&T (NYSE:T)
  • General Motors (NYSE:GM)
  • Bristol-Myers Squibb (NYSE:BMY)
  • Chevron
  • JPMorgan Chase

As of the end of October, the ETF's dividend yield was a sizable 3.15%.

Foolish bottom line
Gather more information before deciding on which ETF is best for your investment objectives. One good place to collect opinions is our new Motley Fool CAPS community. Check out what lots of investors think about the iShares Dow Jones Select Dividend Index.

Learn more in:

Go here for the complete list of ETF contenders in our CAPS tournament.

Longtime Fool contributor Selena Maranjian owns shares of no company mentioned in this article.For more about Selena, view her bio and her profile. Bank of America and JPMorgan Chase areMotley Fool Income Investorpicks. Merck was once an Income Investor choice, while AT&T was a former Stock Advisor pick. The Motley Fool isFools writing for Fools.