A few definitions up front:
Your own dot-com means you paid a registrar fee for your domain name (the dot-com itself) and pay for web hosting – even if the hosting is a cheapo $5-a-month thing.
Free blog means you use a freely available service such as WordPress, Blogger, LiveJournal, Xanga or the like.
Most people are perfectly happy going the free route because of the price tag. But you may be wondering what you get when you actually pay for a domain and hosting.
The short answer:
More freedom, better presence, less hassle.
The long answer:
Avoidance of the "flag" button
Something that truly annoys me about free blogs is the dreaded flag button. It’s your blog, you author it and expect that you should be able to write about anything you want, right?
Yes, you can write about anything you want. But if you tick off enough people they’ll start mashing their mouse clickers on that asinine flag button.
What is flagging? It’s a feature of sorts that allows anybody to report "objectionable content".
For example, Blogger blogs have URLs as [user].blogspot.com. For each one of these is a navy blue bar at the top and that’s where the flag button is.
Most people wouldn’t consider this a big deal, but what if someone just feels like abusing the system and flagging your blog just because they don’t like you? Chances are your blog will be shut down with no warning.
Almost all free blogs have some version of the flag button. It’s a constant reminder to you that sure, you can blog, but watch what you say! Sounds like a freedom killer to me.
If you host your own site, there is no flag button. Ever. And that’s great.
Run PHP and Perl scripts
While it’s true you can run your own PHP or Perl server at home on your own computer, it’s better to have a "live" site out there in a real-world environment.
Free blogs allow you to run… nothing. No PHP. No Perl. No MySQL. None of that. Or if one does it’s very limited and altogether worthless.
With your own dot-com you can run anything you want (within reason, obviously). Maybe you want to install and try out the latest version of phpBB. Maybe you want to host your own WordPress installation. Maybe you want to custom program some PHP. You can do all this even with the cheapo $5-a-month hosters.
Google Preference
It is still true to this day that if you’re looking to get a better search engine rank, Google "prefers" dot-coms first. This is not to say you cannot get a high rank with a free blog, because that’s totally possible. But it just takes a lot more effort.
With your own hosted site you can fine tune things like meta keywords/description, custom coded pages that are more SEO friendly and so on. With the free blog you are forced to take what they give you.
Is all this domain/hosting stuff worth paying for?
It is if you routinely run into limitations of the free blogs that annoy and irritate you. What you’re paying for is presence and the freedom to install and use whatever you want.
I’ve been a domain owner since 1999 – and I wouldn’t have it any other way.

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Rich,
I totally agree. Having a blog on MySpace (don’t laugh it was cool for awhile) and losing post after post in the archives was frustrating. My Blogspot blog was better because all my posts are still there, but not as functional as I needed/wanted. So, I signed up for a free Word Press blog site. Ending in WordPress.com…… Never even moved my Blogspot blog to the new WP site. It’s only $11 a month for my own site w/great tech support (though I’m in learning mode so am not using it for now). Not a bad trade off for my own name/identity, tied only to what I want my brand to be.