Investing in stocks has been a smart long-term move, but as the market has climbed to successive record highs, many investors have questioned whether it's still smart to buy stock now. Below, you'll find three solid reasons that you should still buy stock even when the market is soaring. Let's take a look at them.
1. Stocks have a better risk-reward ratio than alternatives.
The increased volatility in the stock market in recent weeks has made many stock investors reflexively turn to alternatives in search of a smoother ride for their portfolio. Yet when you take a closer look, you'll see that in this latest episode of market choppiness, stocks have actually been less volatile than some investments that many see as being more secure.
For instance, most investors turn to bonds in times of trouble. In recent months, though, soaring interest rates have soared, pushing bond prices downward much more dramatically than stocks. Major bond ETF iShares Core Total US Bond Market (NYSEMKT: AGG ) has plunged to 52-week lows in the past week, and some more aggressive bond ETFs have suffered double-digit percentage declines in value just from the thus-far modest run-up in interest rates. With the upside from bonds fairly limited and that level of risk, using new money to buy stock makes more sense for those seeking a more attractive risk-reward proposition.
2. Some stocks will rise or hold up well even in a downturn.
In times of trouble, investors tend to look at the stock market as a cohesive unit. Yet while correlations exist that make stocks tend to trade in tandem, strong companies can withstand or even benefit from the tough conditions that pull the overall market lower, and buying their stock can be profitable as a result.
For instance, five years ago, the financial crisis hit banking stocks hard, but it was the overall recessionary conditions that helped bring the entire market down. Some companies, though, made the most of the recession and gained ground. McDonald's (NYSE: MCD ) , for instance, benefited from the move away from more expensive casual restaurants, meeting customers' needs with expanded menu offerings that still offered solid value for those who'd moved down from other eating-out options. Similarly, Family Dollar (UNKNOWN: FDO.DL ) and several other deep-discount retailers poached business from higher-cost alternatives as households cut their budgets.
I'm not saying that McDonald's and Family Dollar will necessarily be winners in the next downturn, because current conditions are much different and each company faces new challenges that could hold them back. But whatever drives the next market correction or bear market, there'll be some industry or company in a position to profit from it, and looking closely at the cause of the correction will yield some good investment ideas.
3. Companies have put measures in place that should help earnings for years to come.
Many concerned investors have pointed to high profit margins as potentially being unsustainable. They argue that as a result, it doesn't make sense to buy stock at current levels and that you should wait to invest until what they see as the inevitable reversion of corporate margins to more historically normal levels.
Yet this analysis ignores the long-term improvements that companies have made to boost profits. Perhaps the most notable is the locking-in of cheap long-term financing, as companies have taken advantage of low interest rates to get the cash they need not just now but well into the future. Some of the largest and most creditworthy companies in the economy, including Microsoft (NASDAQ: MSFT ) and Wal-Mart (NYSE: WMT ) , have turned to the debt markets to raise capital not out of need but rather as an opportunistic strategy to minimize their long-term funding costs. Such moves will help keep margins higher even when interest rates rise, as those companies with enough foresight to get long-term financing will reap the benefits for years or even decades to come.
Don't give up
It's understandable to be reluctant to buy stock when the prices are high. But by being discriminating with your purchases and focusing on positioning your overall investment portfolio as well as you can, you'll find that the reasons to buy stock outweigh the reasons to keep your money elsewhere over the long run.
Of course, long-term success often comes with short-term bumps in the road. For instance, after its sterling performance in 2008, McDonald's turned in a dismal year in 2012, underperforming the broader market by 25 percentage points. Looking ahead, can the Golden Arches reclaim its throne atop the restaurant industry, or will this unsettling trend continue? Our top analyst weighs in on McDonald's future in a recent premium report on the company. Click here now to find out whether a buying opportunity has emerged for this global juggernaut.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.