Investing in stocks is one of the best ways to build financial wealth. Most people understand the basics of owning stock. However, there are different categories of stock, with each category having its own pros and cons. Let’s take a look at a popular category of stock, known as blue-chip stock, and why you should invest in it.
Blue-chip stock definition
In simple terms, blue-chip stocks are stocks that belong to well-established companies. These companies usually have the following major characteristics:
- An incredibly stable earnings track record
- No major outstanding liabilities
- A proven track record of solid growth
- A large market cap
- A solid reputation built over several decades
- They’re leaders in their respective industries
In addition, most blue-chip companies pay reliable dividends to their shareholders, even when business is not as strong as is typical for them.
Here are some examples of top blue-chip companies in the UK:
- Royal Dutch Shell
- British American Tobacco
- Legal and General
- Rio Tinto
What kind of investors do these stocks appeal to?
Blue-chip stock appeal to investors who are seeking quality and reliable companies with a history of growing profits and regular dividend payouts.
Unlike other companies, blue-chip companies are less risky to investors in periods of economic uncertainty due to their dependable earnings. Indeed, even in bear markets, blue-chip stock prices do not decline as much as those of growth companies which don’t pay dividends to shareholders.
Blue-chip stocks are therefore quite appealing to and highly suited for the portfolios of conservative and risk-averse investors.
Why invest in blue-chip stock?
Smart investors know that to make consistently good returns in the long run, your portfolio must be reflective of different investments types and different sectors.
As mentioned by the Money Advice Service, diversification – which involves spreading your money between different asset classes and investment products – helps lessen the risk of your investments under-performing or even losing money.
As part of a diversified portfolio, blue-chip stocks offer one of the best ways to reduce risk. Though blue-chip companies are not completely immune to market downturns (no company is, after all), their deep pockets allow them to outlast many market downturns.
The prolonged effects of a market downturn, such as a recession and the resulting huge decrease in revenue, might make less established companies falter. The unique characteristics of blue-chip companies, however, allows them to remain strong even in the worst of times.
That’s one reason that many financial institutions have blue-chip stocks as one of the two pillars of their investment portfolios (with the other pillar being bonds).
As an investor, you might also want to invest in these stocks because not only do they provide a store of wealth in anticipation of capital appreciation, but they also provide regular dividend income.
While blue-chip stocks are a relatively safe investment, it is useful to keep in mind that it may take them a long time to grow. They are therefore best suited for long-term financial goals. But what if you also want to take some speculative short-term risks with your investments?
A good strategy is to open a stocks and shares ISA and have the vast bulk of your portfolio in a diversified group of blue-chip investments while leaving a small amount for higher-risk opportunities.
This way, you get the best of both worlds. The majority of your assets stay relatively protected but you still get to have fun chasing some hot opportunities.
Some offers on MyWalletHero are from our partners — it’s how we make money and keep this site going. But does that impact our ratings? Nope. Our commitment is to you. If a product isn’t any good, our rating will reflect that, or we won’t list it at all. Also, while we aim to feature the best products available, we do not review every product on the market. Learn more here. The statements above are The Motley Fool’s alone and have not been provided or endorsed by bank advertisers. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK has recommended Barclays, Hargreaves Lansdown, HSBC Holdings, Lloyds Banking Group, Mastercard, and Tesco.