You may have heard of blue chip stocks before.
They are a type of stock that has been around for a long period of time and they are considered to be one of the safest and most popular stock investments available.
They come with a lot of pros, but also have their share of cons too.
In this blog post, I cover 10 important pros and cons of blue chip stocks that you should know about before making an investment decision.
10 Pros And Cons Of Blue Chip Stocks
5 Pros Of Blue Chip Stocks
There are many advantages of blue chip stocks.
Here are the important ones you need to know about.
#1. Increased Returns Through Dividends
One of the biggest pros to investing in blue chip stocks is that they typically pay out dividends.
This means you will receive a share of their earnings each quarter, which can be very important for long term investors who are looking for steady growth over time.
As long as the company does well financially and continues to make money, the dividend payments should continue and you will get a share of it.
For example, let’s say a stocks growth rate is 4% annually but they pay a 3% dividend.
When you combine the two, you as an investor can expect to receive a return of roughly 7% annually.
#2. Low Volatility
Another major benefit of blue chip stocks is that they are considered low volatility investments.
A blue chip stock tends to be less volatile than small cap or mid-cap stocks, which means there will not be as much fluctuation with their stock price over time.
This is because these companies tend to be older, more mature companies with a long track record of success and steady earnings.
The chances of major issues are slim, and as a result, they tend to be stable stocks.
This makes it easier for investors who do not have a lot of experience to invest in these stocks because they are less likely to lose their money quickly due to high volatility.
However, this is not always the case, as overall market volatility or unexpected bad news can make investing in these stocks a wild ride.
What are some blue chips that investors tend to buy?
Here is a short list:
- Apple Inc
- Berkshire Hathaway
- Johnson & Johnson
- JP Morgan
- Proctor & Gamble
- United Health Group
Here is a more complete list of what are considered blue chips to invest in.
#3. Less Downside Risk
Most blue chip stocks also have low risk.
This means you can expect a relatively smaller loss with a blue chip stock compared to other types of investments.
For example, if the market crashes 20% you can expect your portfolio to drop less than this amount because a large portion of your assets are in blue chip stocks.
This is because of the point above.
Investors know that chances are low that these companies will go out of business should an economic downturn hit.
So when the market drops, these stocks tend to drop less.
Understand however this doesn’t mean a blue chip stock won’t ever fall 20% or more.
If an economic recession or other financial crisis hits, these stocks will be impacted.
They are not immune to large losses, it just isn’t a common thing for them.
Finally, because blue chip companies are well established, investors know that they can more quickly recover from a downturn and get be back to stable earnings.
This also helps with stable stock prices.
#4. Stable Long Term Returns
Many investors choose to buy and hold these types of investments for years or even decades at a time.
They know these are financially sound companies with a history of solid returns, so they are comfortable buying and holding for the long term.
This helps with the price stability of the stock price.
With fewer people trading the stock and more people investing in it, the price won’t fluctuate as much.
#5. Well Regulated
The final benefit is that blue chip stocks are also often well regulated.
This means the company has to follow all of the rules and regulations that come with being a publicly traded stock, which helps protect you as an investor.
However it can be more expensive for these companies due to compliance costs, so this is yet another reason why they typically have lower returns than other types of investments.
5 Cons Of Blue Chip Stocks
There are many reasons to invest in blue chip stocks, but you can’t ignore the negatives.
Here are the biggest drawbacks of blue chip stocks to consider.
#1. Low Growth Rate
One of the major cons with blue chip stocks is that they typically have a low growth rate.
This means you likely will not see double digit future growth with a blue chip company.
If you are an investor who is looking for high rates of return over time, blue chip stocks are not for you.
They will provide you with only moderate growth potential.
#2. Poor Dividend Yields
Another downside of blue chip stocks is that they typically have low or in some cases, no dividend yields.
To understand this better, the dividend yield is simply the annual dividend amount divided by the share price of the stock.
So if they pay regular dividends of $3 per year and the stock is trading at $100, the yield is 3%.
Many blue chip companies do not need to offer a high yield because so many investors are willing to invest in these stocks regardless of dividends.
As a result, you see many blue chip stocks with yields under 3%, which is less than the historical inflation rate.
With that said, it is also important to look at the dividend growth rate as well.
Some blue chips may have just started to pay a dividend or decided to start increasing their payout.
In this case, you could see a high dividend yield in a few years if you stick around.
#3. Blue Chips Won’t Outperform Stock Market Indexes
Another con of blue chip stocks is that they typically don’t outperform stock market indexes.
In order to outperform the stock market, you need to invest in a basket of investments from various asset classes.
This includes faster growing small cap stocks and international stocks.
- Read now: Here is the importance of a diversified portfolio
- Read now: Discover 10 pros and cons of small cap stocks
For example, if you only invest in large cap stocks, you might earn 7% while the market as a whole earns 9%.
Always remember that risk and return are related.
In exchange for the lower risk of investing in blue chip stocks, you give up some potential return.
#4. Expensive For Small Investors
For small investors, blue chip stocks can be really expensive.
Some companies do have low price per share values like $50 or less, but these are not common.
In fact, many have share prices of $100 or more.
As someone with a small amount of money, this could deter you from investing in these stocks.
However, you can always buy shares of blue chip companies through mutual funds and exchange traded funds (ETFs), which is an easier way to invest.
Just know that these investment vehicles tend to charge a fee, which will lower your return.
Another option is to look for a broker that offers fractional share investing.
This allows you to buy partial shares as opposed to whole shares.
- Read now: Click here for the pros and cons of fractional shares
- Read now: Here is how to invest a small amount of money
And many times, you can invest as little as $5 or $10 at a time.
One of my favorite online brokers is M1 Finance, which does allow for fractional investing.
#5. Limited Chance Of Large Returns Quickly
With small cap stocks, you can earn high returns, even double your money, in a short amount of time.
This is for many reasons, including a fast growing company and a low number of shares outstanding.
When owning blue chip stocks, you don’t have the opportunity of large returns over a short period of time.
This is because the company is older and has established product lines.
Even if a new product is created, it doesn’t have the same impact it would on a smaller company.
For example, a company with revenues of $100 million creates a new product that will generate $100 million just doubled their income.
But a company with revenues of $1 billion creates a product that will generate the same $100 million only see a small increase in income.
Add to this the large number of shares outstanding and it is hard to move the stock price a lot on big companies.
There are the biggest pros and cons of blue chip stocks.
Even though there are drawbacks to this investment, all investors should have a portion of their portfolio invested in blue chip stocks.
While the annual return is lower than other stocks, the stability will help you lower your risk and for many people, this means staying invested for the long term.