Why should blue chip stocks be your starting point when creating a diversified portfolio and what exactly defines blue chip stocks? In this post, I…answer those questions and more.
The original article has been edited here for length (…) and clarity ([ ])
Question # 1: What Is A Blue Chip Stock?
[Such] stocks tend to be large companies that have been around for a long time. They also are in the mature stage of the business lifecycle. This means they have predictable income and sales and there are rarely any surprises.
Here are a few names of blue chip stocks that will help you to better understand what qualifies as one.
As you can see, blue chip stocks tend to be household names for the most part. Now that you have a better idea of what a blue chip stock is
Question #2: Why Should Blue Chip Stocks Be Your First Investment?
1. Because blue chip stocks are mature companies that have a solid balance sheet, they are good at providing steady and consistent growth. This is because their product lines and sales are established. People know and like their products and will continue to do so.
On the other hand, you have small cap stocks. These companies are just starting out, so their earnings and revenues can swing wildly from one quarter to the next and from year to year. As a result, many investment professionals recommend limiting the amount of money you invest in small cap stocks. In fact, all professionals agree that blue chip stocks should be the foundation of a portfolio.
2. Another great reason to start investing in blue chip stocks is because of the income, or dividends they pay out. Since these companies are mature in the growth cycle, they tend to not need a lot of cash reinvested in order for the business to grow. Because of this, many decide to reward shareholders by paying out ever increasing dividends. These dividend payments only increase the return a shareholder earns by investing in these companies.
As of this writing, the average dividend yield of blue chip stocks is just under 2%. The higher the yield, the more dividend income you can expect to earn…
3. …Earlier I mentioned how large, mature companies tend to not have wild earnings and revenue numbers from year to year but there is another advantage to the stability of earnings that large cap company’s offer…[and that is] stock price stability. When the market drops, many times large company stocks tend to drop less than other stocks. This is because investors can rely on these companies to continue to churn a profit.
For example, if a major recession hits and consumers stop buying, a small company with few sales could easily go out of business if sales drop too far but a large company does not risk going out of business when sales decline. Yes, sales will slow for these companies during a recession, but not to the tune of investors worrying if the company can survive. As a result, investors flock to the safety of blue chip stocks, which helps to limit some of the losses during a market collapse.
At the end of the day, if you are building an investment portfolio, you have to start off by investing in blue chip stocks. I know most people want the sexy returns that small companies offer, but you cannot build a sustainable long-term portfolio by only investing in small company stocks. You are simply taking on too much risk. Do yourself and your finances a favor and start by investing in blue chip stocks and then building a diversified portfolio around these holdings.