Why You Should Buy Individual Stocks Instead of Dividend ETFs

Exchange-traded funds, or ETFs, are very popular these days. It's not hard to see why: They offer the liquidity of all-day trading, as opposed to mutual funds, which are priced once at the end of each market day. In addition, exchange-traded funds frequently charge much lower expenses and fees than traditional mutual funds.

The simultaneous rise in popularity of dividend-paying stocks has opened the floodgates within the ETF landscape for a slew of dividend-focused ETFs. These funds offer the convenience of a one-stop solution. They allow investors to own baskets of the market's highest-quality dividend stocks. At the same time, though, an analysis of the yields offered on popular dividend ETFs reveals a troubling trend -- one that should compel investors to consider individual stocks instead.

Show me the yield
There are now an abundance of dividend-oriented exchange-traded funds to choose from. One of the most popular choices is the Vanguard Dividend Appreciation ETF (VIG) , which is a convenient, low-cost way to own several of the market's premier dividend-growers. At the same time, though, even a cursory analysis of the Vanguard fund should leave investors with some concerns. Specifically, the fund's yield of just 2.1% -- barely equal to the yield on the broader S&P 500 index -- leaves a lot to be desired.

Digging deeper, we find that many of the Vanguard fund's top 10 holdings pay much better yields than the fund itself. Consider that retail juggernaut Wal-Mart Stores (WMT) , fast-food giant McDonald's (MCD) , and integrated energy major Chevron (CVX) each reside within the fund's top holdings, and each stock provides a much better yield than 2.1%.

Not only do these individual stocks offer strong, market-beating yields, but they're also among the best dividend-growers out there. Wal-Mart has increased its dividend every year since it first declared a dividend of $0.05 per share in March 1974. Earlier this year, the company upped its distribution by a hefty 18%, and now yields 2.5% for new investors.

McDonald's has increased its dividend every year since its first dividend in 1976, and yields 3.2% at current prices. Even better, it's been a full year since the company last increased its dividend, so investors should fully expect a dividend boost in time for its next payout.

Not to be outdone, Chevron is no slouch when it comes to rewarding investors with strong dividend payments. In April, Chevron bumped up its dividend by 11% to its current level of $1 per share, paid quarterly. This increase marks 26 consecutive years of dividend raises. At recent prices, Chevron yields an impressive 3.2%.

The Foolish takeaway
To be sure, the Vanguard Dividend Appreciation ETF is a great choice for investors to gain exposure to the market's blue-chip dividend stalwarts. Moreover, you won't have to deal with exorbitant management fees and expenses that many mutual funds carry. As a result, the Vanguard Dividend fund represents a solid choice for more risk-conscious investors.

But for those investors who aren't afraid to embrace the risk of investing in individual equities, you can do even better. For all the merits of the Vanguard fund, the fact is you aren't earning the yield you should be. The fund merely matches the yield on the broader market, and although the Vanguard fund is likely to produce above-average dividend growth, that doesn't do much for investors who need strong income now. And of course, by owning individual stocks, you won't have to pay any fees at all.

As a result, it may be wise to consider cherry-picking the best holdings from the Vanguard fund and buying the individual stocks themselves. You can easily form the foundation of a solidly diversified portfolio with Wal-Mart, McDonald's, and Chevron. For investors willing to wade into the waters of individual stock ownership, you can reap the rewards of an even better portfolio yield than many dividend exchange-traded funds currently offer.

Want to Retire Wealthy?
The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report " 3 Stocks That Will Help You Retire Rich " names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.