Benefits of Blue Chip Stocks for Your Portfolio
The benefits of blue chip stocks include the size, durability and stability of the underlying companies. Generally, blue chip stocks are the largest, most well-known and most established stocks on the market.
As a result, people tend to trust blue chip stocks to bounce back after a bear market or economic downturn, based on the long-standing reputation of these companies.
But what are the benefits of blue chip stocks? Why should you invest in them? Should you invest in them at all? Read on – that’s what we’re discussing today.
Why Are They Called “Blue Chip” Stocks?
The benefits of blue chip stocks come from their long history of dominance and stability in the markets. But why are they called “blue chips”?
The term actually comes from poker. In poker, blue chips hold the highest value on the table. Similarly, blue chip stocks often have the highest value and largest market capitalizations on Wall Street.
Because they are so well known and highly valued, many investors of all types find comfort and stability in them. Investing in blue chip stocks is the exact opposite of wild speculation in penny stocks or new companies with shaky balance sheets and income statements.
How Much Are Blue Chip Stocks Worth?
There is no required amount of money a stock must have to enjoy the benefits of being a blue chip stock. Some people claim they must be worth at least $5 billion but others suggest blue chip stocks must be worth at least $10 billion.
These stocks are worth so much money because they’ve usually been around a while. Sometimes these companies have been around for generations and are household names.
But it’s not just the size that counts. The benefits of blue chip stocks for investors come from being stable, financially secure and reliable, which is why investors tend to trust them i times both good and bad.
Characteristics of Blue Chip Stocks
There is no universal consensus on what counts as a blue chip stock or on their exact benefits. But there is a cluster of characteristics that generally belong to them. These characteristics include the following:
- Stability – Generally, blue chips have been around for decades. During that time, they will have demonstrated a remarkable amount of earnings stability. Plus, they will have potentially shown dividend safety as well.
- Consistency – Blue chips also show consistency throughout time. For example, if they are also dividend stocks, they pay and grow dividends steadily. Also, they show consistently high returns of capital and returns on equity (ROE).
- Size – These stocks are generally large-caps with market capitalizations of $5 billion, $10 billion or more. Enterprise value is often among the largest on the market.
- Components of Market Indexes – Usually, blue chips are components of a market index. Examples of market indexes include the Dow Jones, the S&P 500 and the Nasdaq Index.
These characteristics combined will likely identify the real blue chip stocks.
But just to know what they are isn’t enough. You need to know the real benefits of blue chip stocks to understand how to take advantage of their power.
Benefits of Blue Chip Stocks
There are a number of different benefits of blue chip stocks. Let’s take a look at some of these so you can understand their full value.
1. Strong Financials Mean Safe Dividends
Dividend investors look for dividend safety. After all, if the company stops paying a dividend, then you’re no longer a dividend investor. The strong financials of blue chips stocks tend to make their dividends very safe.
Generally, blue chip companies have strong balance sheets, income statements and cash flow statements. This means that in good times – and sometimes in bad times as well – they will be able to keep paying their dividends out to investors.
2. High Returns on Your Investment
The stock market tends to average about an 8% to 10% return, although if you go back far enough (i.e. before the Great Depression) it’s actually more like 12%.
Most investments don’t do as well as stocks, and many stocks do not do well at all. But blue chip stocks have historically done as well as or better than the broader stock market.
Historically, another benefit of blue chip stocks is that they tend to return between 8% and 12% annually when you reinvest the dividends – which you generally should.
3. A Safe Harbor
A third benefit of blue chip stocks is that they tend to be safe harbor stocks. Compared to things like penny stocks or risky high-growth flash-in-the-pan startups, the ol’ reliable blue chips generally won’t let you down in the long run.
Now, that doesn’t mean you can’t lose a lot of money in the short term. You could lose a third or even half of your invested in wealth in a steep market downturn.
But blue chip stocks tend to be of the buy-and-hold variety – meaning that when you hold them for 30 years or more, they are going to come roaring back and earn you those high returns we discussed earlier. That means these stocks are relatively safe and very few of them will go bankrupt.
4. Tax Consequences
A major benefit of buying and holding blue chips stocks is the generous tax consequences they can have if you buy and hold them. When you do not sell out of your position, your tax liabilities on any gains are deferred.
In fact, if you continue to hold them after you die, you likely still won’t have to pay taxes on them. And often, neither will your descendants.
There are tax laws that make it so that many held gains passed on from the deceased to their children are completely forgiven by the government. This protects your wealth and enhances your return on investment.
Concluding Thoughts on Blue Chip Stocks
Blue chip stocks are powerful investment vehicles with many benefits. If you buy and hold a diverse portfolio of blue chip stocks for long enough, you will likely earn great returns over a period of decades.
If you’re interested in the latest news and the latest thinking on blue chip stocks, be sure to subscribe to the free Investment U newsletter in the subscription box below.
Generally, blue chips stocks can be a terrific investment. Don’t put all your money in one stock, of course. But if you invest for the long haul, you will truly see the benefits of blue chip stocks.
About Brian M. Reiser
Brian M. Reiser has a Bachelor of Science degree in Management with a concentration in finance from the School of Management at Binghamton University.
He also holds a B.A. in philosophy from Columbia University and an M.A. in philosophy from the University of South Florida.
His primary interests at Investment U include personal finance, debt, tech stocks and more.