Buy Individual Stocks Instead of Dividend ETFs

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Exchange-traded funds are all the rage these days, and for good reason. As opposed to traditional mutual funds, ETFs trade throughout the day, and often have significantly lower fees than their mutual fund peers. In addition, investors wary of buying individual stocks find solace in the diversification these funds provide.

In particular, ETFs focused on dividends have seen pronounced buying interest from investors. Products such as the Vanguard Dividend Appreciation ETF, with ticker symbol VIG, are well-known throughout the investing community as a simple, convenient way to build a one-stop portfolio of America’s best blue chip stocks.

However, investors with a keen eye and a bit of risk appetite can build just as diversified a portfolio, and simultaneously produce a much higher yield than many dividend-focused ETFs currently provide.

You can do better

While the Vanguard Dividend Appreciation ETF is certainly a plausible way for investors to buy a bucket of profitable, dividend-paying large cap stocks, investors should strive to do better.

In fact, the Vanguard ETF doesn’t provide the yield many investors would prefer from a dividend-focused fund. The current yield on the fund is approximately 2.1%, just about on par with the yield on the S&P 500 Index. It doesn’t appear that investors are better off, at least from a yield perspective, from investing in the Vanguard fund versus simply buying the market.

Curiously, many of the Vanguard fund’s top holdings currently pay dividends that far exceed the yield on the ETF itself. To be precise, of the fund’s top ten holdings, which comprise nearly 40% of the fund, nine of them pay current dividend yields greater than the yield on the ETF.

Cherry-pick the fund’s top holdings

Stocks such as discount retail giant Wal-Mart (NYSE: WMT), soft drink king Coca-Cola (NYSE: KO), and diversified industrial 3M (NYSE: MMM) are included in the ETFs top 10 holdings. Each of these highly-profitable, universally-known stocks has been paying (and importantly, increasing) dividend payouts to shareholders for decades on end.

These three stocks have enviable dividend track records and can be the backbone of your portfolio. The dividend yields on Wal-Mart, Coca-Cola, and 3M sit at 2.4%, 2.7%, and 2.4%, respectively. These three stocks in isolation already put you ahead of the Vanguard fund, in terms of yield. If you add in an even higher-yielding stock, like health care juggernaut GlaxoSmithKline (NYSE: GSK), which pays a current dividend yield in excess of 5% annually, you can juice your portfolio’s yield even further.

Why choose these stocks?

Quite simply, because these four represent some of the biggest, most profitable companies in their respective industries.  These companies carry some of the most valuable brands in existence and will provide solid dividend yields year in and year out, regardless of the broader economic climate.

Wal-Mart has increased its dividend every year since the first declared dividend of $0.05 per share in March 1974.

Coca-Cola is one of the most established, consistent companies in the world, with annual revenue in excess of $48 billion. The company’s earnings per share have increased 59% since 2008.

Meanwhile, 3M raised its dividend early this year, which marked the 55th consecutive year of dividend increases. Furthermore, 3M has paid uninterrupted dividends to shareholders for an amazing 96 years in a row.

Lastly, Glaxo's management remains steadfast in their commitment to increasing its payout. The company declared a fourth-quarter dividend higher than its quarterly payout last year.  Glaxo's four quarterly dividends in 2012 amounted to 74 pence versus 70 pence in 2011, an increase of more than 5% year over year.

The instant portfolio

While I’ve only selected four stocks to form the foundation of a portfolio, it’s worth mentioning that these stocks come from a variety of industries. By gaining access to a retailer, a consumer staples stock, an industrial, and a health care company, you’ve got many of the necessary bases covered immediately.

This strategy might not be for all investors. Extremely conservative investors afraid of dipping their toes into individual stock-picking might be understandably wary. However, for those with at least some appetite for higher risk-taking, you can secure a 3% portfolio yield, assuming equal weighting of these four stocks. Making things even better, you’ll be able to avoid the expenses and fees that come with fund investing.

The Vanguard Dividend Appreciation ETF is a solid fund that will suit many investors just fine. On the other hand, if you’re interested in producing an even higher level of income than this fund provides, it’s entirely possible to do so by cherry-picking some of this very fund’s top holdings.

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Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends 3M and Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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