Researching large-cap stocks, I came across a list of the 25 largest exchange-traded funds (ETFs) by assets under management. Number 19 was iShares' Dow Jones Select Dividend Index Fund (ARCA:DVY), an ETF that tracks the index of the same name. It's finishing off a great 2011, up about 6% as of December 19. Carrying momentum into the New Year, I'll explain why investors can expect good things from the ETF in 2012 and beyond. (For related reading, see How To Pick The Best ETF.)
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Interest Rates
With interest rates continuing at historic lows, baby boomers search high and low for ways to finance their retirement needs. Bonds no longer cut it. As a result, investors are assuming additional risk in order to deliver better returns. Many choose dividend-paying stocks as the investment vehicle for making this happen because they protect against inflation in two ways: by increasing dividend payments in most years and secondly, through the increased prices consumers are charged by the dividend-paying companies themselves. As of November 30, its 30-day SEC yield is 3.57%, which is 149 basis points higher than the Barclays Aggregate Bond Fund (ARCA:AGG), which tracks the total U.S. investment-grade bond market. (For more information, read Why Dividends Matter.)

This is where it becomes evident that dividend investing is not without risk. The total return of the dividend ETF over five years, through the end of November, is 2.41% annually. This compares with an annual return over five years of 6.32% for the bond ETF. But before you rush out and purchase the bond ETF, consider that the total return for the dividend ETF over the past year was 6.76%, 174 basis points higher than the bond ETF.

The over $9 billion fund owns 101 stocks as of December 21 with its top 10 holdings accounting for 21.26% of the total net assets. The index itself is selected from dividend-paying companies in the Dow Jones US index that have a positive five-year dividend-per-share growth rate, an average payout ratio of less than 60% over the past five years and an average daily trading volume of 200,000 shares or higher. Changes are made annually after the close of trading on the third Friday in December. The most important component in the stock selection process for the fund is dividend yield, with average daily trading volume a close second. The three largest holdings of the fund, whose weightings vary slightly from the index, are Lorillard (NYSE:LO), Lockheed Martin (NYSE:LMT) and VF Corp. (NYSE:VFC). In addition, this diversified fund has investments in 11 different sectors, with utilities, consumer goods and industrials accounting for 66.06% of the portfolio. (To learn more, read Risk and Diversification: Diversifying Your Portfolio.)

The Bottom Line
If you're tired of picking stocks and just want to make a sensible investment, the iShares Dow Jones Select Dividend Index Fund is an excellent choice. If you're inclined to invest outside the U.S., iShares also has the iShares Dow Jones International Select Dividend Index Fund (ARCA:IDV), which invests in places like Australia and the U.K., although it hasn't done nearly as well in the past year. (For related reading, see Does International Investing Really Offer Diversification?)

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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.