If you're mulling a new stake in oil giant Chevron (CVX +0.00%), you're in good company. After a brief bout of bearishness in July, the stock has rekindled the bullishness seen for the better part of the past year and a half. Up 22% since June's low, Chevron shares are now 66% higher for the past 12 months, and still chugging.
Before plugging into this hot stock simply because it's leading the marketwide charge, there's another option you may want to consider. Making the right choice between the two ultimately depends on asking yourself the right questions, and giving yourself honest answers.
NYSE: CVX
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Start with the right questions... and answers
It doesn't have to be Chevron. It can be any hot stock, or any individual stock for that matter. The question is: Why do you want to own it, and where does it fit into your overall portfolio?
If your only answer is that it's performing better than most other stocks right now (or could in the foreseeable future), that's not a great answer.
See, as the old cliche goes, past performance is no guarantee of future results. In fact, the hotter the stock, the more likely it is to suffer a wave of profit-taking. And even if that stock eventually recovers, can you stomach all the volatility it dishes out in the meantime? Owning several other stocks can take the rough edges off of an individual stock's sharp pullback, but do you actually own enough of the right other stocks to serve as that buffer? If you do, go for it -- step into Chevron, or whichever company you've been eyeing of late.
If you only own a handful of stocks -- or if the investment you're considering would be the only one you hold -- there's a better idea: Buy a diversified basket of stocks like the Dow Jones Industrial Average (^DJI 0.26%) first.
You'll never get the sort of explosive gains from an index fund like the SPDR Dow Jones Industrial Average ETF Trust (DIA 0.23%) that you will from a Chevron or any other single stock. You also won't get the sort of steep pullback an individual stock can dish out from time to time. What you will get is the average performance of 30 solid blue chip stocks. You'll also get the average, collective performance of several different sectors.
Most of all, you might sleep better at night.
In the short run this may or may not matter much. In the long run, though, it can matter a great deal. As the graphic below indicates, energy stocks like Chevron were severe underperformers from 2012 until the middle of last year.
Or, think of it like this... can you correctly identify the very top for the energy market, and step out of Chevron before it gives up any meaningful ground? In the same sense that most investors didn't believe oil and gas prices were set to roar beginning in the middle of 2021, it's unlikely most investors will be able to see the energy market's cyclical top until well after it's happened.
None of this is meant to steer you clear of individual stocks forevermore (although it wouldn't be the worst thing in the world if you only ever owned index funds); there's an argument to be made for owning individual companies. It's simply to suggest most investors are best served by plugging into the broad market's overall long-term gains instead of trying to beat the market by picking stocks.
It's hard to beat the odds
Still not convinced? Try this on for size. Every year, Standard & Poor's looks back at the performance of all the mutual funds offered to U.S. investors. Last year, a little over 83% of large mutual funds failed to outperform the S&P 500 (^GSPC 0.61%).
Think about that for a moment. Despite having access to mountains of data and being able to devote a full-time effort to the cause, the vast majority of market professionals couldn't even match the market's total gains.
SNPINDEX: ^GSPC
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And that subpar performance can't be dismissed as a fluke or chalked up to unusual circumstances. For the past three years, a little over two-thirds of the large-cap funds available in the United States trailed the S&P 500. For the past five years, nearly three-fourths of these funds underperformed the S&P 500. Over the course of the past 10 years, 83% of mutual funds couldn't keep pace with their large-cap benchmark.
The moral of the story is, it's hard to beat the market... not impossible, but certainly challenging to do so. You're often better off not trying to, as the effort to beat the market by being a stock-picker often prompts you to make decisions that ultimately lead to underperformance.
Start simple. Start with a basket of quality stocks you can tuck away for years on end, then selectively add individual long-term stock positions around that core index position. Chevron just isn't a name to prioritize owning until you own shares of plenty of other companies.
