Many aspiring college investors have thought about dabbling in oil. It’s a commodity in demand, traded every day on exchanges worldwide, and offers the potential for significant returns.
But oil is not for everyone. Before rushing to buy a futures contract or calling your broker about spot prices, consult the following beginner’s guide to investing in oil (including which type of investors are best suited to do it, and how much of your portfolio oil should comprise).
First, it must be stated: investing in oil may not be the best place for a total beginner to start. For one thing, oil (like all commodities) is subject to rapid, day-to-day price fluctuations. An investor who has never been through the ups and downs of a market might be shell-shocked to log into their brokerage account and see that their oil holdings have fallen 50% overnight. Just look at what Syria has done to oil prices.
Oil is also what might be called a “hands-on” investment strategy. Unlike an index fund (where you simply pay in while computers invest your money across the entire stock market), oil typically requires deciding when to buy and sell. This is fine for full-time investors who have the time to monitor their investments all day. For those just starting out, it will be difficult to keep the watchful eye oil investing calls for. Frankly, research suggests few individuals can pull it off at all.
The exception to this rule is oil ETFs, a more passive strategy discussed later in this article.
Small Part of Your Portfolio
Even for experienced investors, oil should typically consume only a small percentage of your overall investment portfolio. The reason, again, is diversification and modern portfolio theory. It’s never wise to stake your entire portfolio on a single volatile commodity that can either double or halve overnight (as commodities frequently do).
Having 20 or 30 percent of your portfolio in oil would be terrific if oil prices skyrocketed. That much is obvious — but what happens when we suddenly overthrow the Iranian government and cheap oil floods the market, causing oil prices to fall? Answer: the plunge takes 20 or 30 percent of your portfolio down with it. Not smart.
On the other hand, keeping a small slice of your portfolio (say, two or five percent) in oil positions you to prosper from upside without being devastated by downside. It’s all about finding the right balance between risk and reward. Again, the more of a beginner you are, the more conservative you ought to be.
Strategies for Oil Investment
There’s no “one right way” to invest in oil. Feel free to pick one or more of the following strategies based on your unique resources, strengths, and weaknesses as an investor:
Buying Oil Stocks Directly
The most straightforward strategy is to simply buy shares in oil-producing companies like ExxonMobil, ConocoPhillips, British Petroleum, or Chevron. When their share prices rise or fall, you prosper or suffer in direct proportion to how many shares you purchased.
Buying into an Oil ETF
A more diversified approach, oil ETFs spread your investment capital across a broad swath of oil securities (including futures, discussed below) without overly investing you in any one category of them. Oil ETFs include United States Oil Fund (USO), WTI Crude Oil Fund (CRUD) and S&P Global Energy Index Fund (IXC). Oil ETFs represent a long-term strategy roughly similar to an index or mutual fund.
Investing in Oil Futures
Intended for advanced investors only, oil futures contracts entitle you to buy and sell options to purchase or sell oil (and hopefully profit) based on your predictions of where the market is going. Futures contracts are often difficult to understand if you are not extremely well-versed in their contractual language, and therefore, are not advisable for beginners. Minimum buys (say, $10,000 or more) also tend to prohibit college-aged investors from getting involved.
These strategies are listed in order of easiest/least risky to hardest/most risky. See USA Today’s article, Investing in Oil Without Getting Your Hands Dirty, for more information on ETFs.
Seek Impartial, Commission-Free Advice
Finally, I cannot stress enough the importance of getting your oil investment advice from impartial sources. By impartial, I mean someone who is not going to get a commission by selling you oil investments.
The conflict of interest here should be obvious: only the most upright and ethical broker will tell you “I don’t think you should invest in this” when they stand to make hundreds or thousands of dollars from you saying yes.
Instead, seek out advice from fee-based financial planners/investment advisers who have no direct stake in your eventual decision. With no financial incentives clouding their thinking, these advisers will likely give you their objective judgment and not just a sales pitch to fatten their next commission check.
The Bottom Line
Properly done, oil investing can become a viable part (emphasis on the word “part”) of your long-term investing strategy. As a single commodity, it should not make up a large portion of your portfolio by itself. But by investing in a way that reflects your investing profile, oil can make solid contributions to your annual returns for years to come.
What's your thought on investing in oil?