Why blue chips are gold in your portfolio

Blue chip stocks, named after the highest-valued chips in poker, are prized investment holdings representing ownership in some the most successful firms in the economy. If you want to invest in companies that have proven their ability to ride out economic downturns and maintain profitability even when times get tough, you should take a look at these stocks.

Basic characteristics of blue chip stocks

A blue chip stock is a share of ownership in a large, well-established and stable company that has a long history of consistent earnings growth and dividend payments. Blue chip companies have a large market capitalization, strong balance sheets and good cash flow. Blue chip stocks have low volatility overall, but strong changes in the overall market can also have strong effects on these stocks. The performance of an individual blue chip company will tend to correlate closely with the performance of the S&P 500.

Many blue chip stocks are household names, such as the big banks, Suncor, and BCE. However, a company doesn't have to be a household name to be a blue chip; you may have never heard of some of them. There are tens of thousands of publicly traded companies, but only a few hundred are considered blue chips.

Blue chip advantages

Blue chips are supported by proven business models, slow but consistent growth and strong cash flow. They are a good option for capital preservation and their dividend payments not only provide income, but also help protect against inflation. Blue chips tend to be stable even during recessions and, because they're widely owned by both individuals and institutions, they have high liquidity. Blue chips are about as safe an investment as you can get, when it comes to investing in stocks.

Blue chip disadvantages

In exchange for the stability associated with blue chip stocks comes slow growth and lower returns. Growth stocks and real estate investments can offer higher returns to investors willing to accept greater risk. Blue chip stocks can also be expensive, and if you're investing in individual stocks, you need to make sure to diversify to avoid company risk.

How to invest in blue-chip stocks

To invest in blue chips, you have a few options. You can directly purchase individual shares through a brokerage. If you choose this route, you might to want use a value investing strategy to try to purchase these stocks when they're underpriced.

An important characteristic of blue chip stocks is that they not only consistently pay dividends to their shareholders during times of better and worse company performance, but they increase their dividends more years than not. To locate stocks with an excellent track record of dividend increases, see the S&P's Dividend Aristocrats and Mergent's Dividend Achievers.

You can also invest in a basket of blue chip stocks through mutual funds and ETFs. Some of these funds have the term "blue chip" in the fund name, like the Bridgeway Blue Chip 35 Index, which provides diversification across a number of economic sectors, has a net expense ratio of 0.15% and has historically performed similarly to the S&P 500, though it invests less in consumer discretionary companies and more in information technology than the S&P.

Other funds are essentially blue chip funds even though they don't use those words in the fund name. An example is Vanguard's Dividend Appreciation (VIG) ETF. Its goal is to track the Dividend Achievers Select Index, an index of U.S.-based companies that have increased their regular annual dividend payments for the last 10-plus consecutive years. VIG has a 0.13% expense ratio and is heavily weighted toward consumer staples and industrials, which together make up 45 per cent of its holdings.

The bottom line

If you want to invest in market-leading companies with a proven track record and low volatility, look no further than blue chip stocks, mutual funds and ETFs. They may not be as glamorous as the latest growth stocks, but they can quietly help you achieve your long-term investing goals.

At the time of writing, the author did not own shares of any securities mentioned in this article.