For many investors, choosing between the S&P 500 and individual stocks is a fairly straightforward decision because there’s a ton of information online comparing these two investment types. But since blue-chip stocks aren’t exactly the same as conventional ones, it can be hard to determine whether they’re a better option than the S&P 500.
The S&P 500 might be a better investment choice than blue chip stocks because it’s inherently diversified, cheaper, and slightly less risky than blue chip stocks. This is true despite both investment types providing almost identical average rates of return.
Read on to learn more about investing in blue chip stocks and the S&P 500 and how the two investment options compare.
A Primer on Blue Chip Stocks and S&P 500
For the sake of clarity, let’s briefly cover the basics of these two investments.
The S&P 500 is a market index designed to track the performance of a select group of stocks, typically those of the top 500 companies by market capitalization.
It’s worth noting that while the market capitalization is a crucial part of the index’s eligibility criteria, other factors like a company’s liquidity and its portion of outstanding shares are also considered. But that’s beside the point as far as today’s post goes.
What I’d like to emphasize is that the S&P 500 is widely recognized as a performance benchmark for the US stock market, but you can’t invest directly in the S&P 500. When people talk about investing in the S&P 500, they’re actually referring to buying shares of an index fund or ETF whose portfolio is intentionally designed to mimic the market index’s performance.
Now that you understand what I mean by when I refer to the S&500 as an investment, let’s talk about blue chip stocks.
Blue chip stocks are issued by blue chip companies. For a company to qualify as a blue chip, it must be:
Without going into too much detail, here’s what the above three characteristics loosely translate to:
Blue chips are typically mature, stable, long-lasting, and profitable industry leaders that investors view as relatively safe investments. Think the likes of IBM, JP Morgan Chase, Walmart, Amazon, Apple, or other safe stocks.
Here’s where things get a bit confusing for the average investor trying to choose between the S&P 500 and blue chip stocks. More often than not, blue chip stocks are featured in the S&P 500 index. In fact, many stocks earn blue chip status when they become members of the S&P 500, which raises a critical question.
How would one investment be better when there’s an overlap between an S&P 500 ETF/index fund and blue chip stocks? And if there’s a better investment between the two, which one is it?
Let’s find out in the next section before you take this newfound knowledge to the markets.
Blue Chip Stocks vs. S&P 500
Every investor has a different profile in terms of investment strategy, risk tolerance, budget, among other factors.
Additionally, different investors may want to use either investment for varying reasons. For instance, investor A may want to add diversification to their portfolio, while investor B may prioritize income generation through dividends.
Ultimately, choosing between these two investments trickles down to your investment goals, needs, and generally who you are as an investor. But the fact that the cliche “it depends on your needs” holds, in this case, doesn’t mean I won’t help you out.
Here’s what to consider when choosing between the S&P 500 and blue chip stocks:
- The degree of diversification offered by each investment.
- The size of the investment budget you’re working with.
- Risk and return
Let’s discuss each of these considerations in greater detail.
The Degree of Diversification Offered by Each Investment
If you’re familiar with the general structure of S&P 500 index funds and ETFs, you probably know that they edge out individual stocks when it comes to diversification. That, too, goes for blue chip stocks.
Index funds and ETFs tracking the S&P 500 index hold hundreds of securities in their portfolios by design. When you buy a single share of such funds, it comes with little portions of all the assets held in the fund’s portfolio.
Put otherwise, a single share of any S&P 500 index fund/ETF gives you exposure to 500 large-cap stocks in the US stock market, providing instant diversification.
On the other hand, one share of a blue chip company only exposes you to that particular firm, which is nowhere near the degree of diversification offered by an S&P 500 index fund. And while it’s possible to diversify by acquiring several blue chip stocks from companies in different sectors, you’d need quite a large sum of money to do that because blue chip stocks are typically expensive.
That brings us to the next consideration: your budget.
Your Budget Size
Generally, you’d need a larger budget to build a diversified portfolio of blue chip stocks due to their typically hefty price tags. While you may be able to afford one stock of your favorite blue chip, you need at least 30 to build a diversified portfolio.
That’s what makes blue chip stocks more capital intensive than index funds for an investor looking to build their portfolio from scratch. But if you’re looking to beef up an existing portfolio with a few blue chip stocks, their hefty price tag might not be too big of a deal because you can buy as few as you can afford.
What about fractional shares?
Sure, these can help make it cheaper to diversify with blue chip stocks. However, choosing this route raises another issue: liquidity.
Fractional shares don’t trade on the market, as you can only buy and sell them through a brokerage. What’s more, they might not be available at your brokerage because not all allow fractional investing.
On the other hand, S&P 500 index funds and ETFs make it cheaper to diversify. Partly, this is because you don’t need as many shares of different funds as blue-chip stocks to gain exposure to hundreds of different companies across various industries.
Case in point? The Vanguard S&P ETF, whose share price around the time of writing is $424.66. For that amount, you gain instant exposure to over ten equity sectors, something that would be impossible to achieve with a similar amount when buying individual blue chip stocks.
Risk and Return
When it comes to risk, it’s a no-brainer that S&P 500 index funds and ETFs carry less than individual stocks because the former investments are more diversified. However, things aren’t clear when we talk about blue chip stocks because they’re usually touted as safe investments, and rightly so.
While both the S&P 500 and blue chip stocks are low-risk, the former investment type has a slight leg up because its performance is pegged on more companies.
As for the average rate of return, there isn’t much of a difference between blue chip stocks and the S&P 500. According to cmcmarkets.com, the average annual rate of return on blue chip stocks is about 10%, a similar value to the market indices (such as the S&P 500) they’re often featured on.
If I had to choose strictly between these two investments, I’d be leaning more towards an S&P 500 index fund/ETF. That’s because it provides instant diversification with less initial capital and slightly lower risk than blue chip stocks, despite both investments having similar average rates of return.