The Weekly Dividend

I have an unhealthy emotional attachment to dividend-focused ETFs. I rarely experience emotions about individual stocks, but I just can't help but feel warm and fuzzy every time I hear about a new dividend-focused ETF coming to market. This week, let's explore the best of these bad puppies and see how they can add some pizzazz to your portfolio.

A match made in heaven
My love of dividend-focused ETFs stems from two beliefs -- that ETFs provide a simple, cost-effective way to invest, and that investors can achieve market-beating returns with reduced risk through dividend reinvestment in fat-yielding stocks. Dividends and ETFs are like Oreos and milk -- I like each individually, but combined, they're a delicacy.

The funds work by tracking uniquely designed dividend-focused indices. The indices themselves each have their own quirks and rules of admission, but they all fundamentally strive to create a basket comprised of healthy and established dividend payers.

The dividend-ETF concept is young -- the largest fund in the class is only a little more than three years old. Since that's too short a time to draw any meaningful conclusions about the funds' track records, the best way to gauge the future performance of the funds is by looking at the indices they seek to mimic. How the funds themselves will prove to track them over time is uncertain. What is certain, though, is that the annual management fees, despite being quite reasonable, will diminish your returns measured against the underlying indices.

A few choice offerings
But hey, don't let me turn you off. Below is a table featuring the performance histories of the S&P 500 and the underlying indices of a pair of dividend-focused ETFs that I am thumbs-up on in Motley Fool CAPS.

DVY is your best friend
While I'm high on several PowerShares offerings, including the above High Yield Equity Dividend Achievers Fund and the offbeat Buyback Achievers Fund (AMEX:PKW), the Dow Jones Select Dividend Index Fund is the domestic dividend fund of choice among ETF investors. With an annualized return of 13.6% over the past 10 years versus the S&P 500's 8.4%, the index DVY tracks is giving you outperformance strong enough to make you want to slap your mama.

The fund's $8.4 billion in assets is spread across 117 stocks, all of which have maintained or raised their dividend over the past five years, have an average payout ratio of less than 60% over the same time period, and typically have an average trading volume of at least 200,000 shares a day. It probably would not surprise you to learn that the fund is top-heavy in terms of sectors -- financials make up roughly a third of the fund, while energy stocks make up another 15%. The fund's top holdings, dividend stalwart Altria (NYSE:MO) and Income Investor selection Bank of America (NYSE:BAC), represent about 7% of its assets, while the remaining top 10 holdings add another 20%.

The strategy behind the fund is a proven winner. Though you should expect the fund to do a little worse than the index because of fees, I expect that DVY will still be a market-beater over the long haul. As a bonus, the makeup of the fund should also give investors unusually high downside protection in the face of a declining market.

If you have the patience and diligence to build your own portfolio of dividend payers, you might not need a dose of DVY. If you're a Rule Breakers-style investor looking for an instant dose of dividend diversity, though, or perhaps simply looking to avoid the legwork of individual-stock due diligence, DVY marks a simple, straightforward gateway to a diversified stable of dividend stocks.

Adding international flair
If there's one thing an MBA education will try to pound into you -- aside from a pronounced (and false) self-doubt regarding your ability to beat the market -- it is that you can drastically reduce your portfolio's volatility by mixing in a diversified international allocation.

The PowerShares International Dividend Achievers Fund (AMEX:PID) is the closest thing dividend-lovers will find to an international one-stop shop. The fund seeks to track the International Dividend Achievers Index, which only includes the stocks of non-U.S.-based companies that trade on U.S. exchanges, have increased their regular dividends annually for at least five years, and typically have an asset value of more than $2 billion. This screening process allows you to narrow your international investments to a select group of proven firms with minimal effort required.

Such screening is valuable, since unless you're an international man of mystery, you've likely never even heard of most of the fund's top holdings, save perhaps Inside Value pick Lloyds TSB Group (NYSE:LYG).

The fund, which has a three-star rating in CAPS, currently yields 2.7% with an expense ratio of 0.6%. It has outperformed the MSCI EAFE Index by 1.5% annually over the past decade -- certainly nothing to sneeze at.

PID strikes me as a remarkably simple, safe, and effective way to add international diversification to your portfolio, as well as being a bearish dollar play. If I could hold only a single international investment for the next 10 years, call me a conservative ninny, but this would be it.

Further reading
If you're a yield piggy like me, you might want to check out a free 30-day trial of the Motley Fool Income Investor newsletter. If you're thirsting for readings beyond that, check out last week's version of "The Weekly Dividend" or a couple of Foolish dividend-focused articles from the past week:

• My Dividends Are Bigger Than Yours
• The Case for Dividends
• Build Your Dividend Dynasty

Foolish editor Joe Magyer spent all of his free cash flow over the past several years on grad school tuition. He owns shares of the PowerShares Buyback Achievers Fund. Joe's holdings and CAPS profile are always available for your viewing pleasure. Lloyds TSB is an Inside Value pick, while Bank of America is an Income Investor pick. The Motley Fool has an ironclad disclosure policy. No, seriously, clad in iron. The thing weighs a ton.