Why Should You Invest in Blue Chip Stocks?

There are countless great companies, but not all have the esteemed designation as blue chip stocks. There are no universally accepted criteria for what qualifies as a blue chip. However, it’s generally accepted that blue chip stocks are well-established, industry-leading companies, that they have cash-filled balance sheets, and that they have stood the test of time, providing great long-term shareholder value.

Think about companies like Coca-Cola, Procter & Gamble, and Starbucks. You could argue that Coca-Cola’s flagship soda is the world’s most recognizable brand, that you can’t visit any market of any size in a slew of countries without seeing P&G’s products on the shelves, and that Starbucks now has more stores in the U.S. than McDonald’s (which also qualifies as a blue chip). Their presence and impact are undeniable.

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It’s all about reliability

The appeal of blue chip stocks usually comes down to one word: reliability. Investing is inherently risky, and volatility is as much a part of the stock market as the actual stocks themselves. There’s no escaping that. However, you can lean on companies that have proven to provide long-term reliability.

Blue chip stocks have battle-tested business models that have shown to be effective regardless of broader economic conditions. When recessions (or similar economic conditions) hit, a newer company operating in a niche market will often get dinged and may even fail. There is a general confidence that a blue chip company like Walmart or Johnson & Johnson will do just fine.

By no means does this make blue chip stocks foolproof or risk-free — General Motors‘ 2009 bankruptcy during the Great Recession warns us about assuming such. But thanks to their resources and sheer size, an investor can be confident the vast majority of blue chip stocks will find a way to manage in rough, short-term economic storms. How long the recovery takes can vary, but at some point, great companies find their way to brighter days.

What some investors may find unappealing about blue chip stocks are their often average growth rates. Investors have different investing styles: Some look for value, some focus on dividend income, and some prefer growth stocks. Blue chip stocks aren’t going to be the ones that return 100% in a year.

Dividends matter

Dividends often play an underrated role in investors’ total returns, especially when reinvested. In fact, in the 50 years between 1960 and 2021, reinvested dividends accounted for around 84% of the S&P 500‘s total return. Part of being a blue chip stock is having a reliable dividend that increases yearly. And yet, there are exceptions to this truism, such as Berkshire Hathaway which regularly produces double-digit returns but doesn’t offer a dividend.

It’s one thing for a stock to offer a dividend, but it’s another thing for that dividend to be sustainable long-term. Even some blue chip stalwarts, like Walt Disney and Delta, will occasionally encounter situations where they have to suspend their dividends for a time (the COVID-19 pandemic forced these two stocks to do so).

By making consistent investments and building a nice stake in blue chip stocks over time, investors can set themselves up to receive significant supplemental income in retirement. With even a modest 2.5% dividend yield, investors could receive $2,500 in annual income per $100,000 invested.

Diversification is still important

A diversified portfolio is one where you are investing in companies of different sizes and operating in different sectors of the economy. Unfortunately, blue-chip stocks are all large-cap companies. Larger companies have their perks — such as being more stable and less prone to volatility — but also have shortcomings, such as a reduced chance for hyper growth.

Most top companies today were once small-cap companies, and completely ignoring them would be doing yourself a disservice as an investor. After all, where there’s room for hyper-growth, there’s room for lots of money to be made. Amazon was nowhere close to a blue chip stock in the early 2000s, yet every $1,000 invested in the company then would be worth tens of thousands today.

So, while blue-chip stocks offer a relatively safe (if less productive) investment option, they should form just one portion of your overall portfolio. How big that portion is will be up to you and your financial adviser to decide.

John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Stefon Walters has positions in McDonald’s. The Motley Fool has positions in and recommends Amazon.com, Berkshire Hathaway, Starbucks, Walmart, and Walt Disney. The Motley Fool recommends Delta Air Lines, General Motors, and Johnson & Johnson and recommends the following options: long January 2024 $145 calls on Walt Disney, long January 2024 $47.50 calls on Coca-Cola, long January 2025 $25 calls on General Motors, short April 2023 $100 calls on Starbucks, and short January 2024 $155 calls on Walt Disney. The Motley Fool has a disclosure policy.