Oil prices recently broke $100 a barrel and the stock market tanked. This week, Federal Reserve Chair Ben Bernanke proclaimed that increasing commodity prices could negatively impact the U.S. recovery. Moments like this are instructive for observing our own emotional schizophrenia. On one hand, our greed glands are pumping, and we want to get in on the action. We don't want to feel stupid by missing a further run up in oil prices. On the other, we still have memories of 2008 and recall the panic of a falling market, which keeps us fearful of buying at the top. And let's throw in the envy factor: Most of us have a friend that will inevitably disclose how he or she predicted this and bought oil stocks a year ago.
What's an investor to do? Bulls say that the world needs more oil than producers can pump, refine, and distribute, and this is getting worse as the Chinese start owning and driving cars. What about alternative energy? They claim that these sources won't make a meaningful impact for years. Bears say that OPEC will just turn on more oil because if they let prices get too high, their customers will have more incentive to find alternatives.
[See ETF Basics: How To Invest in Commodities.]
There are no easy answers to these questions, but if you want specific energy exposure, here is portfolio of exchange-traded funds (ETFs).
Listed below are ETFs that give you ownership in over 300 operating companies that are all impacted by price of oil and gas. We've included a recommended percentage allocation to each fund, so for example, with $10,000, you'd buy $2,000 of IXC, IEO, and IEZ and so on.
Diversified global companies (20 percent). You want to own the largest globally-diversified oil and gas companies. If you buy iShares S&P Global Energy (IXC), you'll buy stock in all of the 95 large players like ExxonMobil, Chevron, and BP.
Exploration and production (20 percent). These large companies that exclusively own and produce oil and gas are fully exposed to energy prices. The higher the price of oil and gas, the more they earn. Instead of trying to understand each company, buy the iShares Dow Jones US Oil & Gas Exploration Index (IEO), and you'll own 60 companies like Occidental Petroleum and Apache.
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Services (20 percent). These companies support the energy industry through services and equipment. They charge their customers more as energy prices increase. Buying the iShares Dow Jones US Oil Equipment Index (IEZ) gives you ownership in 44 energy services companies like Schlumberger, and Halliburton, and mid-sized ones like Noble and Helmerich & Payne.
Alternatives (10 percent). Alternative energy sources may save us from the eventual depletion of fossil fuels and if so, we want exposure to wind, solar, and Tesla cars. By owning the PowerShares WilderHill Clean Energy Index (PBW), you buy a stake in 60 companies all over the world that focus on greener and generally renewable sources of energy, and technologies that facilitate cleaner energy.
Pipelines (15 percent). Owning master limited partnerships (MLPs) gives you ownership of pipelines that transport crude oil, natural gas, and other refined petroleum products. MLPs generate fee-based revenues, which tend not to be directly tied to changes in commodity prices. Much like how Simon Malls owns shopping malls, which provide distribution for retailers like Macy's, these companies provide distribution for energy companies. The JPMorgan Alerian MLP Index ETN (AMJ) gives you exposure to the large U.S. pipeline companies like Enterprise Products (EPD) and Kinder Morgan (KMP). And it pays over a 6 percent dividend.
Utilities (15 percent). The Utilities Select Sector Index (XLU) includes electric and gas utilities, independent power producers including PG&E, Southern Company, and Duke Energy. XLU pays over a 4 percent dividend.
We do not recommend energy ETFs that own futures contracts like United States Oil (USO) or United States Natural Gas (UNG). These ETFs are baskets of contracts (not companies) to buy actual gas and oil in the future. For many technical reasons, these contracts can lose value irrespective of oil and gas prices, and they have not performed as advertised.
[See How Contango Affects Your Investments.]
So if you want to be in on the energy action, up or down, this is the most logical and low-cost way (under 0.5 percent annual fees) to apportion your investment in the sector. Hopefully you'll be the one bragging at a party in 2015.
Mitch Tuchman is CEO and founder of MarketRiders, an online investment advisory and management service helping Americans invest for retirement. MarketRiders gives investors greater peace of mind knowing that they are leveraging the best thinking of Nobel Laureates and the investing methods used by the world's most elite institutions and wealthiest families. MarketRiders is on the investor's side, helping reduce investment costs and risks, and increasing retirement savings.
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