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SMART INSIGHTS FROM PROFESSIONAL ADVISERS

This 5-Stock Portfolio Makes the Perfect Summer Gift

Giving stocks offers the potential for greater wealth over the long term and an invaluable lesson in investing.

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Summer is often the season for important milestones in many younger people's lives. To commemorate these events, such as graduations and weddings, too often we fall back on giving money, and your gift is distinguished from the next only by the dollar amount.

See Also: 12 Stocks to Earn Dividends Every Month

Instead, you might consider giving a gift of a five-stock portfolio held in dividend reinvestment plans (DRIPs). Your total cost to set up such a portfolio, depending on the price of the stock that you select, is somewhere around $500. In addition to the financial benefit, which is likely to compound to substantial wealth over the long-term (which I will demonstrate below), this gift will give the recipient a first-hand experience with a logical approach to investing.

By "saving" in the stock of the companies in a portfolio of DRIPs, your young investor has the opportunity to build wealth by participating in the growth of the economy in the easiest and most efficient manner possible. How much wealth? It could be millions of dollars!

Let's assume that the graduate or the young couple (or you on their behalf) invests $5,000 a year for the next four years—spread evenly among the five-stock portfolio made up of high-quality, dividend-paying companies. Let's also say that no further investments are ever going to be made into those accounts. The results can be astounding.

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What would your $20,000 turn into by retirement? The answer is more than $1 million, assuming an 8% average annual return over the 47 years until your high-school graduate reaches 65 years of age.

Is an 8% average annual rate of return realistic? Let's look at what occurred during the past 47 years. Even though the Dow Jones industrial average made no net progress between 1966 and 1982, it has grown 18 times over since then to the present level of around 18,000. So what can you expect from a portfolio of high-quality, dividend-paying stock over a 47-year period, especially if they are carefully selected and tend to increase their dividend payouts on a regular basis?

Might you obtain a higher rate of return, say, 10%? That's the long-term rate of return of the market in general as calculated since 1926 based on Ibbotson Research. Our portfolio may well provide above average returns compared with the market as a whole, but let's accept a 10% average annual rate of return. In that case, your $20,000 investment would provide more than $2.5 million.

Here's how the calculations look:

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The reason for such a great benefit is that nothing is lost to investment fees. Once an investor is enrolled in a DRIP, subsequent investments can be made without going through a broker and without fees—and dividends can be automatically used to purchase more shares (and fractions of shares). That way, every penny is used to create a growing stake in the underlying company. What's more, the likelihood of the investment staying put over the long term is maximized when the assets are held in DRIP accounts. The "staying put" part of this equation is key.

The following are five companies we would include in a long-term portfolio. To qualify for inclusion, the company must have a long history of dividend increases. We kept total return in mind, looking for companies with excellent earning and dividend growth rates as well as sustainable business models. We limited our selections to companies that do not charge fees for investing through the plan, and we sought to diversify the companies in terms of industry.

Finally, we decided to limit the selection to five companies that are household names—stocks the gift recipients are likely to be familiar with and can relate to.

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AFLAC (symbol AFL) is a leading insurer that's maintained after-tax operating margins of more than 10% since 2007. An extremely investor-friendly company, AFLAC has paid increasing dividends for 34 consecutive years, raising their dividend by 5.1% in 2015.

Johnson & Johnson (JNJ) has a market capitalization of about $280 billion, and its business is split between drugs, medical devices and products on one hand and consumer goods such as Band-Aids, Baby Shampoo and topical medicines on the other. The dividend has been increased for 53 consecutive years.

International Paper (IP) is the dominant company in the area of paper and packaging, both in the U.S. and abroad, with almost $23 billion in annual sales and a market capitalization of about $16.5 billion. With a yield of about 4%, it has raised its dividend for six straight years (and its latest increase was 10%).

General Mills (GIS) is a major food processor with products such as Yoplait and Pillsbury. The dividend has been increased for 12 straight years and has never been cut in the 114 years that the company has been paying them.

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ExxonMobil (XOM) is the largest oil company that resulted in the breakup of the old Standard Oil conglomerate (at $333 billion market cap) and routinely logs the largest annual profits of any American company. Its dividend has been increased for 33 straight years.

See Also: 5 Dividend Stocks to Buy While They Are Cheap

Vita Nelson provides financial information centered around DRIP investing at www.drp.com and www.directinvesting.com. She is the editor and publisher of Moneypaper's Guide to Direct Investment Plans, Chairman of the Board of Temper of the Times Investor Service, Inc. (a DRIP enrollment service), and co-manager of the MP 63 Fund (DRIPX).

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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff.