The Disadvantages of Blue Chip Stocks for Your Portfolio
In my previous article on the benefits of blue chip stocks, I went over several reasons why these stocks can be great for building wealth.
However, it would be wrong to ignore the fact that there are also some disadvantages of blue chip stocks. In today’s article, I will go over some of these disadvantages.
As a reminder, blue chip stocks are those of large, stable companies that have produced reliable returns over a long period of time. They are also usually listed in an index like the S&P 500 or the Nasdaq. Many blue chip stocks are famous brands that you know quite well: Coca-Cola (NYSE: KO) or General Electric (NYSE: GE).
Blue chip stocks can be a crucial portion of your portfolio for building wealth. But there are still drawbacks you should be aware of – after all, you don’t want to start a new investment without knowing all sides of the story. So here are a few disadvantages of blue chip stocks that you should know.
Some Disadvantages of Blue Chip Stocks
1. Blue Chips Have Only Moderate Growth Potential
One of the most important disadvantages of blue chip stocks are that they have only moderate growth potential. This may seem counterintuitive; after all, these are some of the biggest, most successful companies in the world. Shouldn’t they offer the biggest returns?
That may seem logical to you, but the answer is an emphatic no. Because these companies are already so large and successful, they have very limited room for growth.
As a result, you are much more likely to do about as well as the market with a blue chip stock than beat it. After all, the market averages and indices are largely driven on the backs of these blue chip stocks because they are, in fact, so large.
Now, I’m not saying there’s anything wrong with doing roughly as well as the market. According to our investment calculator, if you take $1,000 and earn average market returns of roughly 10% for 30 years, you’ll wind up with $19,828 at the end for a gain of 1,882%. That’s pretty solid.
But let’s say you could earn triple that return with a high-growth small-cap stock we’ll call “SML.” After investing in SML for 30 years at 30%, your $1,000 would become a whopping $7,255,202. That’s quite a long way from $19,828.
2. They Are Older, Less Innovative Companies
Let’s pretend for a moment that you’re a young, hip technological savant who knows all about the latest gizmos and products in the tech sector (and maybe you are). Kudos to you! That gives you a competitive advantage in the stock market.
That’s because it is a competitive disadvantage for blue chip stocks that these companies are older, much more established and less likely to be taking advantage of these cutting-edge tech abilities and products.
Because cutting-edge technologies and innovations drive so much growth and wealth in our economy, it is easy to see how this can help small, agile and innovative companies earn superior returns compared with their older blue chip brethren.
As a result, this is a significant disadvantage of investing in blue chip stocks. After all, the more you squirrel away in IBM or Coca-Cola, the less you will have available to invest in the next hot tech startup that will grow at a 1,000% clip over the next year.
That doesn’t mean blue chips shouldn’t be a foundational component of your stock portfolio. It just means that you should also look to other investment opportunities to help you get big gains.
3. Blue Chip Stock Dividends vs. Growth
Another disadvantage of blue chip stocks is that they tend to focus on dividends over growth. Dividends can be beneficial because they help supply you with a steady income from your investments… but they aren’t always as helpful when it comes to building wealth. Oftentimes, investors who are more concerned with dividends are funding their retirement.
But if you are trying to build capital, growth stocks can get you there much faster. And the best growth tends to come from smaller cap, startup-type companies that are investing heavily in themselves rather than distributing profits to shareholders.
Now, don’t think this makes blue chip stocks a bad choice. It just means that depending on what stage of your life and investment journey you’re in, you may want to tilt heavier into non-blue chip stocks.
4. Downside Risk
The last of the disadvantages of blue chips stocks we’ll discuss is their significant downside risk, meaning there’s always some chance of a sharp drop in value.
The reason for this is simple. Blue chip stocks are followed closely by analysts and news is reported about them often. As a result, investors are generally well-informed of good news – and bad – about the company.
The good news tends to get priced in quickly, which is one reason it is hard to time a stock. On the other hand, sudden and unexpected bad news can knock the stock down with a powerful wallop.
It’s a trade-off. In the long run, most blue chip stocks will help you generate income through dividend growth and build some wealth through capital appreciation. But in the short term, you may need to deal with some volatility and short, sharp drops or shocks.
Final Thoughts on the Disadvantages of Blue Chip Stocks
As we have seen, there are some significant disadvantages to investing in blue chip stocks, but there are also plenty of benefits. How much of your portfolio to put into blue chip stocks will depend on your particular situation.
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Now that you know the disadvantages of blue chips stocks, you can make a well-informed decision about how much to invest in them. With the right balance, your portfolio will be positioned to build and protect your wealth for many years to come.
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.