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"You saw it first at Bloomingdale's!" is the great slogan of the New York City retailer that just opened shop in San Francisco. In the same spirit, here's your first glimpse of a cogent explanation of dividend-based index funds. You saw it first in the Contra Costa Times.

Index funds were invented by economics professors at Stanford who threw darts at the Wall Street Journal and proved that if you bought stocks randomly and didn't pay to have them managed you would beat 85 percent of all other efforts to manage money.

Mark Hulbert, in tracking money mangers for 25 years, found that only 15 percent of them had beaten broad market averages -- and this statistic does not include all the ones that folded their tents and went out of business.

Index funds, then, make good sense for people who want to increase the possibility of beating more than 85 percent of all attempts to manage and invest money. So the question is, "Which index fund makes the best sense for me?" Morningstar identifies more than 150 funds that are so-called "passive" investments.

Warren Buffet recommends the S&P 500 index as the best bet for the average investor. The total market index is a representative sample of the entire market, meaning that it includes both large and small companies. Theoretically, you have more diversification, but not as much as you might think. Why? Because the amount of any company's proportionate share of the total in the fund is a function of that company's market value. In the S&P 500, for example, just the largest 10 companies of the 500 can represent more than 30 percent of the entire fund's value.

The several hundred index funds available today offer passive investments for almost every type of company. There are index funds of small companies, value-oriented companies, REITs, foreign companies, etc. Until recently, all of these indexes used the size of the market capitalization (total value of outstanding stock) to determine the proportionate share of each company to be owned by the mutual fund. The latest wrinkle is a new index fund approach that weights investments not by size but by the relative amount of dividends each pays out.

A new mutual fund family, WisdomTree Investments, has launched itself to capitalize on what they feel is a better mousetrap. What got my attention was the announcement that Arthur Levitt was onboard as one of their senior advisers. He was the former SEC chairman who fought on our behalf to have stock options treated as an expense, so he deserves our business.

The Wisdom Tree approach is to use Exchange Traded Funds -- mutual funds that are valued from second-to-second throughout the day. Once purchased through a brokerage firm ($8 per trade at most true discount brokers), the annual expense ratios are typically less than 0.5 percent. When investing for income, keeping these annual expenses low is absolutely critical.

Everybody is talking about dividends these days. Stock dividends represent a substantial contribution to investment success -- roughly 25 percent of all gains over time are attributable to reinvested dividends. It makes sense to set up an index fund that weights its investments by the amount of the dividends they pay out rather by their sheer dollar value in the market. The Wisdom Tree people, based upon extensive back testing, are convinced that weighting investments by dividend payout amounts will improve results over the traditional capitalization weighting. Meanwhile Morningstar makes the point that 25 dividend-paying stocks account for more than half of the total dividends paid out by the S&P 500. The so-called "Dogs of the Dow" are the 10 highest-paying (as a percent of stock price) companies making up the Dow Jones Average. Both of these stock groups are paying an average of around 4 percent in dividends right now.

Those of us close to retirement, or already in the early years of an eccentric personal retirement lifestyle, need to be protecting against inflation while at the same time generating enough money to pay expenses. We owe it to ourselves to explore the tools that offer stock appreciation while generating income taxed for the moment at only 15 percent.

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