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  • Writer's pictureLucas McNamara

Blue Chip Basics

Many of us have heard of a “blue-chip stock,” but what does this term really mean? The expression blue chip is derived from a blue-colored chip in a poker set which is usually worth the most money. Blue-chip stocks are a classification of companies denoted for their high value and stability. Traditional blue-chip stocks include the common market leaders such as Coca-Cola, Apple, and Berkshire Hathaway. Through market instability and financial turmoil, these stocks have generally felt less of an effect. This statement may seem attractive in the case of a bear market, but through bullish periods, blue chips have historically followed or even lagged behind broad indexes such as Standard and Poor’s 500. To be classified as a blue-chip, a company must have a proven track record of stable growth, a large market capitalization, and a steady set of dividend payouts. A company that is not known for dividend payouts is not disbarred from being classified as a blue-chip, but the majority of the stocks categorized do release substantial amounts in dividends each quarter.

Blue Chip Safety

If you were to view the portfolio of an average wealthy American you would likely find a large portion of their investments going to blue-chip companies. Investors choose to allot their money into blue-chip securities because they are particularly known for stability. The majority of Americans tend to stray away from high-risk investments although they can potentially offer a massive return. Instead, investors value their money and commonly opt for blue-chip stocks that are almost guaranteed to grow. While this speed of growth may not outpace other securities, blue-chip stocks are known to historically gain at a steady rate. Furthermore, these heavyweights usually stay alive in mass-market recessions, resulting in low chances of losses. Blue-chips have been known to be on the receiving end of government bailouts. The term “too big to fail” is commonly thrown toward blue-chips because of the hundreds of thousands of people and the tremendous amount of infrastructure that these companies operate. Specifically, the government tends to bailout these market leaders due to the fact that a loss of one of these companies will significantly derail the rest of the economy.

No Promises

A bet on blue will likely grow your portfolio at a steady rate and offer acceptable returns. However, buyers must be mindful not to fall into the fallacy that investing in blue-chip companies guarantees zero risks. The stock market is inherently risky; there is no definitive sign that can predict the price of a stock in the future. Blue-chip companies are known to be stable and resistant to general market trends, but a degree of failure still remains probable. Large, “too big to fail” companies have in fact failed before. For instance, during the 2000s, General Motors was known as the premier car manufacturer of the time. The conglomerate owned a majority share in many subsidiaries including Chevrolet, Buick, GMC, and Cadillac. The General Motors empire combined to rule the American roads and represented the majority share of the vehicle industry. At the time, General Motors was regarded as one of the safest bets in the market and was far too influential to succumb to failure. As the country negotiated trade deals with foreign countries, the conglomerate began to outsource many of its operations to low paying countries in Central America. American Union Workers watched as their career prospects began to dwindle and the future of American manufacturing collapsed. As a result, union workers in the Midwest states began to strike; the protests halted manufacturing and began to harm GM’s checkbook.

Company-wide unrest continued until the 2008 Financial Crisis when General Motors finally threw in the towel and filed for Chapter Eleven bankruptcy. Due to the significant size and employment of the company, the federal government stepped in and offered a $49.5 billion bailout to the automaker. Shareholders of the corporation felt the effects of the company’s total collapse in parallel and similarly suffered financial losses. The once blue-chip General Motors was left with a nasty reputation and distaste from the American public. While this is just one anecdote of a blue-chip failure, it is important to remember that growth is not guaranteed. Investing in a company with a record for stability and resistance is wise, but thinking that you are clear from risk is simply foolish.

Portfolio Backbones

For the regular investor, putting all bets on blue generally does not offer the greatest levels of returns compared to investing in other sectors of the market. For purposes of retirement or in instances where losses can affect your finances in a significant way, investing in low risk, heavyweight stocks might be the way to go. For the average investor who wishes to take on a bit of risk in order to generate a substantial return, blue-chip stocks should not be the definitive end-all plan. Instead of investing entirely in blue-chip companies, investors should use these stable securities as a sturdy backbone for the portfolio to sprout off of. In a diversified portfolio, blue-chip companies offer a sound level of growth with somewhat predictable payouts. The dividends generated by blue investments can be reinvested within the company or conversely placed into higher-risk securities. Diversification is key; placing entire fortunes into single companies or industries is unwise. Instead, investors should look to allocate their funds toward a broad range of competing companies, industries, and even entire countries. Diversifying into a comprehensive range of locations is known to reduce the overall risk of market turmoil while still generating significant returns. A person may choose to avoid blue-chip companies entirely. After all, the decision to invest in any company is ultimately decided by the sole investor. Placing your money into blue-chip companies is generally regarded as a wise decision by the majority of the investment world. Although these stocks may not be in the headlines of the news for enormous gains or monumental dividends, blue-chip companies offer a stable set of growth rates and payouts that will likely create a well-balanced portfolio.

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