After suffering through a wild ride the past several years, many ordinary investors have thrown up their hands in disgust. But stocks belong in many portfolios, and you shouldn’t banish them entirely and forever. By Jeffrey R. Kosnett, Senior Editor July 27, 2010 Investing in stocks can be maddening. Major market indexes regularly swing 2% to 3% in one day, sometimes in a few hours. All it takes is for a few traders or talking heads to react to a government economic report or to some development in a distant land whose leader’s name you couldn’t remember for a million bucks. For example, the U.S. stock market plunged 2.7% on June 29 on reports of weak home prices and consumer confidence. On July 22, the market jumped 2.5% following upbeat earnings reports from such bellwethers as 3M (symbol MMM), Caterpillar (CAT) and UPS (UPS).In the long run, as Warren Buffett so famously put it, the stock market may still be a weighing machine—that is, it reacts over the long haul to key fundamental measures, such as corporate profits and dividends. But to say, as Buffett did, that the market is just a voting machine in the short run underestimates the degree to which today’s volatility makes the market look more like a crapshoot than anything approximating a rational measuring stick of the health of corporations, both here and abroad. The idea that you or I or even a mutual-fund manager might buy a company’s stock based on fundamental developments seems positively quaint nowadays. Now, large “investors” buy and sell gigantic blocks of indexes—representing tens of millions of bundled shares and occasionally acquired with buckets of borrowed money. It’s as if they were dealing in gold or crude oil or currencies rather than giving a thumbs up or down on 3M or Caterpillar or UPS. These traders have elbowed aside long-term investors. Instead of caring about balance sheets and price-earnings ratios, they learn about high-frequency trading, dark pools, naked access and automated market structures. Where once stocks traded mainly on the New York Stock Exchange, a few regional exchanges and Nasdaq, they now change hands on more than 60 “trading platforms” where enormous numbers of shares move all day and all night—and on weekends, too. Advertisement After suffering through the wild ride of the past several years, more than a few ordinary investors have thrown up their hands in disgust. Typical is Richard Dziallo of Hickory Hills, Ill. In early July, a time of extreme market instability, Dziallo wrote to Kiplinger’s that “the current markets and the volatility and the price fluctuation are beyond my expectations and belief… I have watched premier stocks rise and fall in a tide of mis-beliefs and rumors” as derivatives, exchange-traded funds and other investment techniques and vehicles have helped turn the stock market “into a 24/7, 365-day casino.” From now on, says Dziallo, he will invest only in bonds or put his money in the bank rather than continue to be a “pigeon.” Some professionals echo Dziallo’s frustration. Lee Munson, of Portfolio, LLC, an advisory firm in Albuquerque, N.M., says many wealthy clients are fed up and want out entirely. If you have enough money to last through a long retirement, by all means, cut way back on your allocation to stocks. (See 4 Principles of Managing Money for Those With Lots of It.) As for the rest of you, don’t act too hastily. Stocks belong in many portfolios, and you shouldn’t banish them entirely and forever. (See our collection of 22 model portfolios to find an asset balance that feels right to you.) Below are seven reasons why you should continue to hold some stocks (as long as you accept that share prices won’t be calm and predictable): 1. They pay dividends. Dividends are back in favor with investors, advisers and, fortunately, many chief executives and corporate directors. Cash dividends represent money in your pocket now and don’t depend on the ups and downs of a stock. Plus, a company can boost its payout every year, while the overwhelming majority of bonds and CDs pay the same amount of interest year in and year out (hey, they don’t call them fixed-income instruments for nothing). Advertisement The U.S. stock market, as measured by Standard & Poor’s 500-stock index, yields about 2%. That may not seem like a lot, but it’s more than what you get today from a five-year Treasury note. Moreover, the index, which includes companies that don’t share their wealth, understates the dividend advantage. The average dividend-paying stock in the S&P 500 yields 2.4%, and you can find plenty of good companies that yield far more. Examples: McDonald’s (MCD), 3.1%; Procter & Gamble (PG), 3.1%; Johnson and Johnson (JNJ), 3.7%; and AT&T (T), a whopping 6.6%. (See our list of 15 companies committed to paying rising dividends.) 2. You can use them to play the economy. Naysayers of the prognosticating abilities of stocks like to quote the old quip by economist Paul Samuelson about the market having forecast nine of the past five recessions. Yes, the market is not a perfect predictor of the economy, but it does often offer clues. Typically, stocks tend to fall before a seemingly healthy economy begins to backslide and rise before the economy emerges from recession. We saw that in 2007, when stocks peaked a couple of months before the onset of recession and in 2009, when the market bottomed several months before the economy (the body that dates recessions and expansions still hasn’t called an official end to the downturn that began in December 2007; Kiplinger’s believes the recession ended in the middle of 2009). The main point is that in most cases you’ll want to lighten your exposure to stocks when the economy is firing on all cylinders and add to your holdings when the economy looks flat-out awful. 3. They give you exposure to growth all over the world. The U.S. is no longer the only game in town. U.S. stocks now account for only one-third of global market capitalization. The real growth is in emerging markets, including such countries as India, Brazil, Mexico, Turkey, South Africa and Indonesia. (See our Special Report: Prosper With Emerging Markets.) If you invest (preferably through a good, well-diversified mutual fund) in local industries in these developing markets, such as homebuilding, retailing and finance, you can insulate yourself, to some degree, from the wacky doings in the U.S. market. Knee-jerk traders who dump the S&P 500 because a European bank goes bust may not bother to unload shares in the Sao Paulo or Istanbul markets because they don’t control those markets, and that’s a comfort. 4. IPOs offer fresh hope. Talk that Facebook or a revived General Motors will go public creates a buzz and can give the market a jolt of optimism. In this economy, poorly managed or poorly financed companies have no shot at issuing stock and fooling the public, as happened during the tech bubble of the late 1990s. As long as serious companies still see a future in getting their shares listed and traded, you have to believe the stock market can still be a place where the price of an investment will eventually reflect the value of the underlying enterprise. You’ll just have to endure spells during which traders treat “good” stocks and “bad” ones alike. (See our 2010 Midyear IPO Outlook: A Buyer's Market for IPOs.) Advertisement 5. They’re just too hard to ignore. On Kiplinger.com, you can find what we call a “Tofurky portfolio” because it’s supposed to act like a stock portfolio but doesn’t hold any stocks. It’s done well with its recipe of bonds, bank loans, commodities and energy partnerships; but there aren’t enough alternative investments to go around, whereas there are trillions of dollars worth of stocks. If everyone ditches stocks and piles into other securities, you can bet a bubble will form and eventually burst, as all bubbles do. So as much as I like pipeline partnerships, for example, it’s impossible to make a case for a growth portfolio that’s 100% free of traditional common stocks. 6. Financial reform may help. Scoff if you wish, but if the recently enacted financial-reform law stiffens the backbones of regulators and promotes a saner approach to risk-taking at banks, the result may be fewer panics and mini crashes. Remember this: Whenever there are failures or insolvencies (or rumors of impending trouble) that involve financial firms—as opposed to oil companies, home builders or automakers—the traders’ culture is to sell now and ask questions later. Anything that cuts down on the propensity of overaggressive or misguided financial firms to cause such confusion reduces the chance of a 2008-style meltdown. (See What Investors Should Know About Financial Reform.) 7. Thank heavens for earnings season. Companies issue important fundamental news so infrequently that the arrival of earnings season comes as a relief to regular investors. That’s when they learn whether a company has met expectations and, more important, they get some indication of what the future holds for a firm -- and, by extension, for a sector and sometimes for the entire market. A rally of the sort that occurred on July 22 confirms that plain old commonsense investment news can still translate into winning days for you and me. If only there could be more days like it.