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 more than 35 exchange-traded funds (ETFs) that combine two of Siegel's favorite investment strategies: indexing and dividends. Siegel demonstrated in his 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 is made up of the 100 highest-yielding of the 300 largest companies by market cap in WisdomTree's LargeCap Dividend Index. But unlike conventional indexes, 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 Bank of America -- a company that has been affected by the current credit crunch. 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 and Andy Cross recommend two dividend payers each month to 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 5% on average, and the entire portfolio is beating the S&P 500 by seven 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. Bank of America is a Motley Fool Income Investor choice. Pfizer is an Income Investor and Inside Value pick. No Fool is too cool for disclosure.