Should you invest in blue chip stocks?

Why investing in the boring stocks can be a money making strategy.

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Many novice sharemarket investors are filled with dreams of generating enormous wealth over a short timeframe. In other words, everyone is looking for a way to get rich quick.

But rather than adopting a high risk/high reward strategy and hoping to strike it lucky, there are many benefits to choosing slow-moving blue chip stocks over riskier investments, such as penny stocks.

In times of volatility and uncertainty, these shares are not only a more secure investment, they can also deliver stable returns in the form of dividends. Read our guide to find out how blue chip shares can benefit you in the long-run.

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Updated February 25th, 2020
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Share market volatility

Ever since the Global Financial Crisis of 2008, when Australian shares plummeted by more than 50%, “volatility” has been the word on everyone’s lips. Investors who suffered substantial losses between late 2007 to early 2009 know just how financially devastating a sharemarket crash can be. This means investors and market analysts alike are always trying to predict when the next big fall will come.

In 2016, when the All Ordinaries endured a horror start to the year and slumped 7% in the first two weeks of January, global bank RBS warned that share markets around the world might fall by up to 20% over the course of the year. In such volatile and unpredictable times, so-called “boring” shares can offer a safe and secure investment option.

Blue chip stocks vs growth stocks

You don’t need a risky investment plan to generate wealth from shares. While shares can provide a great long-term investment strategy, if you’re looking to make a quick buck, then investing in shares can be very risky.

Despite this risk, it can be very tempting to take a punt on speculative companies. These are companies that do not have a long, well-established history of providing stable returns to investors. They’re also typically located outside the list of the top 100 companies in Australia. These are sometimes called 'growth stocks' and are often penny stocks.

Blue chip stocks vs penny stocks

Blue chip stocks. A blue chip stock is usually an older, well-established company that has a reliable history of weathering against tough times and of growing profits. Examples include: BHP, CBA, Telstra and CSL.

Penny stocks. Penny stocks tend to trade for less than $5 and are also called micro-cap stocks or small cap stocks. The idea is to buy them for a low price with the promise of big profits later. They're generally riskier, speculative stocks.

While these types of companies may theoretically provide the potential for larger returns, there’s also the risk of incurring substantial losses when you invest in them. In most cases, investing in speculative shares is best left to experienced traders who know what they’re doing and are willing to accept the increased level of risk.

If you’re new to share trading and investing, consider investing in “boring” shares from some of Australia’s blue-chip companies. These are companies included in the S&P/ASX 50, a list of Australia’s top 50 companies, and they tend to have a long history of providing steady returns with minimal risk.

The benefits of dividends

It’s worth remembering that there are two ways to earn money from shares. Not only can you benefit from capital growth in the value of shares over time, but you can also earn an income from dividends and any additional franking credits. Dividends are more often paid out by blue chip stocks, which is part of what makes them so attractive.

A dividend is a company’s way of distributing its profits to shareholders. Many companies listed on the ASX pay dividends twice a year, including a smaller “interim” dividend and a larger “final” dividend. However, not all companies pay dividends to shareholders, and will instead invest all of their profits back into the company.

Dividends tend to be paid by larger, more established companies on the ASX and you can use them to provide a regular, ongoing source of income. This offers you security and stability for the future, while at the same time giving you a chance to benefit from the company’s long-term capital growth.

What are some blue chip shares?

The S&P/ASX 50 is a list of Australia’s top 50 companies. It includes companies with a history of providing steady returns and minimal volatility to investors. These companies are spread across a wide range of market sectors, including:

Banking and financial services

Companies in the financial sector have a history of providing large dividends. This includes companies such as AMP and the Big Four banks: CommBank, Westpac, ANZ and NAB.

Resources sector

As mining is a cyclical industry, resources companies have the potential to provide high capital growth but also have a reputation for underperforming when the mining industry experiences a downturn. Having said that, companies such as BHP Billiton, Woodside Petroleum and Rio Tinto all feature in the S&P/ASX 50.

Retail sector

Retailers tend to offer medium-sized dividends to shareholders, and Woolworths and Wesfarmers (owner of Coles) are popular choices with investors.

Other companies that feature in the S&P/ASX 50 include:

  • Telecommunications giant Telstra
  • Drinks company Coca-Cola Amatil
  • Retail giant Westfield Group
  • Australia’s largest airline, Qantas

Other long-term investment tips

Make a plan

  • Before you start buying or selling shares, consider exactly what you want to achieve with your share portfolio and in what timeframe. Once you have a plan in place you can then choose your investments accordingly.

Don’t panic

  • Share markets fluctuate all the time – look at historical graphs charting the performance of the ASX for proof of this – so don’t panic at the first sign of share prices heading south. Stick to your plan and ride out any dips or down periods.

Consider your investment goals

  • Are you looking for shares to provide capital growth or to generate income? Smaller companies tend to focus more on growth and therefore reinvest profits into their business, while larger companies tend to pay dividends to their shareholders.

Don’t forget about dividends

  • Dividends can provide a stable source of ongoing income during uncertain financial times. Look at companies with a history of paying high dividends to shareholders to see whether they could provide an attractive investment option for you.

Choose companies wisely

  • Blue-chip stocks, also known as large-cap companies, tend to offer secure, stable returns and a minimal level of risk. Smaller companies outside the top 50 or 100 companies on the ASX may provide larger growth potential, but they also come with a much higher level of risk attached.

Research before you buy

  • Looking at a company’s annual reports, earnings and historical performance will help you form a clearer picture of whether it is a sound investment. If you’re using an online share trading platform, you may also be able to access research reports and buy or sell recommendations for various companies.

Know what long-term means

  • In order to ride out any periods of market volatility and enjoy the maximum returns, you typically need to look at an investment time frame of 7 to 10 years when choosing shares.

Consider other investment options

  • Depending on your investment goals and appetite for risk, you may also want to consider other options, such as exchange traded funds (ETFs). ETFs are bought and sold on the ASX just like shares, but they allow you to gain exposure to a share index or other group of underlying assets.

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