Why the glory days could be over for blue-chip shares

Blue-chip shares have long been a favoured investment vehicle for Australian investors. Think of the Big Four banks, resource companies such as BHP and Rio Tinto, and retail behemoths like Wesfarmers and Woolworths - they're staples in many portfolios.

The term blue-chip originated in poker at a time when blue chips were the most valuable in the game. Historically, blue-chip stocks have had several important attributes: they are large, well-known and well-capitalised businesses with dependable earnings and stable, rising dividends.

Such companies still exist today, but there are fewer of them, and they are a bit less safe than they used to be. With rapidly developing technology and globalisation as the basis for business disruption, investors cannot and should not assume a portfolio of so-called blue-chip stocks is as reliable as it once was.

The shock waves caused by COVID-19 have exposed just how quickly and unexpectedly the financial landscape can change - it's still too soon to tell which companies have been merely bruised and which have received serious, lasting damage.

What we do know is that the composition of top stocks is more prone to change than it was in the past - consider that General Motors went bankrupt during the global financial crisis, and the fact that A2 Milk just replaced AMP in the S&P/ASX 50 index. Even blue-chip stocks struggle during tough times.

So, if you've built your investment portfolio around the principle of blue-chip reliability and want to rethink your strategy, what can you do? This is the question many baby boomers and SMSF trustees in particular are currently asking themselves.

Have your cake and eat it too

History and data suggest that the optimal approach for most investors is to focus on portfolio diversification. This can be within an asset class - expanding from a handful of blue-chip Aussie stocks to broader coverage, for example - as well as across asset classes, adding options with different characteristics such as international shares, bonds, emerging markets, and listed infrastructure.

Depending on your situation (Do you have spare cash to invest? Are you still making contributions to your investment account?) you don't necessarily need to sell down your so-called blue chips; rather, you could start to add investments around them to result in a well-diversified portfolio. No need to panic - this doesn't have to be done all at once.

If you have a long investment horizon and are willing to take on higher levels of risk/volatility for the prospect of higher long-term returns, consider adding growth asset classes such as international shares, emerging markets shares and listed property. Exchange-traded funds (ETFs) are a simple, affordable way to get investment exposure to each such asset class on the ASX via one fund (seek quality providers like State Street, Vanguard, Blackrock, BetaShares and Van Eck).

If you want or need a more defensive tilt to your portfolio due to a shorter time horizon or lower risk appetite, then you may lean more heavily on defensive asset classes such as bonds and cash yield (also available on the ASX via quality ETFs).

Should I be picking stocks right now?

You might also be asking yourself: If I don't own any of these companies, should I buy some as they seem to be trading at bargain basement prices? Well, maybe, but there's also no promise that today's prices are bargain levels.

The road to recovery and market outlook are very hard to predict right now, and valuations based on earnings are hard to peg when you don't know what the earnings outlook really looks like.

Picking individual stocks is very difficult for most investors to do effectively, so you might consider getting your blue-chip exposure via ETFs. For example, State Street's STW ETF (which tracks the S&P/ASX 200 index) is heavily weighted to CSL, CBA, BHP and Westpac. For international shares, Vanguard's VGS ETF is heavily weighted to Apple, Microsoft, Amazon and Alphabet (Google). Both of these ETFs provide additional investment diversification because there are also many other companies in their underlying index.

Investing is a long game

Blue chips no longer appear on most poker tables - the game has changed. So, too, has investing - it's a long game, and it demands patience and a cool head.

And, while there's always an element of risk in investing (and poker) diversification is a way of improving your long-term success. There's nothing inherently wrong with owning some of these companies in their own right, but consider whether your portfolio - and your peace of mind - could benefit from additional low-cost diversification that can help provide strong risk-adjusted returns over time.

Get stories like this in our newsletters.