by Archie M. Richards, Jr.
September 3, 2007

Sherman writes, "After retiring several years ago, I placed 10 percent of my portfolio into iShares Dow Jones Select Dividend Index Fund (symbol DVY) for its relatively high current income.

"More recently, I read your fine book, "Understanding Exchange-Traded Funds," and noted your suggestion that 5 percent of a portfolio be allocated to big value stocks - in particular, Vanguard's Value Fund ETF (VTV). Should I switch the DVY I have to the VTV you recommend?"

Your DVY probably stands at a nice profit, Sherman. If you hold it in your own name and not in an IRA, continue to hold, because selling would incur a capital gain tax. At your death, the capital gain will be wiped out, never to be paid by anyone. Since DVY and VTV are similar, tax saving takes precedence.

Within an IRA, however, go ahead and make the switch.

A little more detail follows. For many investors, vocabulary is a stickler:

Exchange-traded funds (ETFs) are mutual funds that can be bought and sold during the trading day. For long-term holders they're less costly even than index funds.

iShares is the trade name associated with the ETFs offered by Barclays Global Investments. The ETF with the stock symbol DVY replicates an index maintained by Dow Jones, called the Select Dividend Index.

Indexes are not investments. Each one measures the performance of a certain group of stocks, in this case, those that pay high dividends.

An exchange-traded fund, an actual investment, parallels the index it tracks. As the index goes, so goes the ETF (except for the operating costs, which are low. A key reason the costs are low is because no stock research is needed. In this case, Barclays Global Investments simply holds the stocks selected by Dow Jones for its index.)

Dow Jones, a prominent publisher, also creates many indexes. As to the Select Dividend Index on which DVY is based, Dow Jones starts with all U.S. dividend-paying stocks and selects those that have the following characteristics:

• The company's dividends have not been reduced in any of the last 5 years.

• The dividends have been less than 60 percent of earnings, assuring that the company has sufficient earnings to support the dividend.

• The stock trades at least 200,000 shares a day.

From this group, Dow Jones selects the 100 stocks that have the highest dividend percentage. The current dividend yield of the exchange-traded fund based on this index, DVY, is 3.4 percent.

Vanguard's exchange-traded fund of big value stocks, VTV, which I recommend, is based on the MSCI US Prime Market Value Index. VTV's current dividend yield is 2.2 percent.

MSCI stands for Morgan Stanley Capital International, a leading supplier of indexes of U.S. and foreign stocks.

The index used for VTV consists of about 400 U.S. value stocks. "Value" means that the price of the stock is relatively low in relation to earnings. For example, if a company's annual earnings are $1 a share and the stock price is only $12, it would be considered a value stock - relatively cheap in relation to the earnings. If the price is $30, it would be considered a growth stock. (The earnings of growth stocks are expected to grow more rapidly than those of value stocks.)

The total return of any stock stems from the dividends plus the price appreciation. Companies that pay more of their earnings in dividends have less money to finance future growth. Over the long term, high-dividend stocks are likely to have less appreciation and lower total returns. Besides, a stock that provides cash in hand has lower risk. Low-risk investments tend to have lower long-term returns.

Most people are likely to live longer than they expect. Everyone, even retirees, should shoot for high total return with reasonable risk.

In the long run, Vanguard's Value Fund (VTV) will probably outstrip iShares Dow Jones Select Dividend Index Fund (DVY). But the two investments are similar. If DVY is held at a profit in a regular account, retain it, to avoid paying the capital gains tax.