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Oil Stocks - How to Invest in Oil Stocks

Should I invest in oil stocks?

That’s a question that a lot of investors have been asking themselves over the last couple of years. The fundamentals of the oil stocks story aside, the case can be made that investing in oil stocks is a reasonable way for the average investor to hedge his individual energy costs (like the price of a tank of gas or your electric bill) with part of their portfolio. It’s interesting that paying an extra $5 a tank at the pump doesn’t feel so bad if you have oil stocks in your portfolio that have just gone up 5% as well. And many average investors can’t trade crude oil directly.

Of course, these are some of the most volatile stocks around, and many of the penny stocks are associated with the energy industry as well. So, how best to invest in oil stocks?

First, you can just make a bet based on the fundamentals, or as a piece of your portfolio to hedge or diversify your portfolio. You would do this by simply holding a static or constant portion of your investments in energy or oil related stocks, say 5 or 10% of your portfolio invested in oil and natural resources stocks.

We favor using sector funds as a tool to invest in oil stocks in our portfolios. But rather than holding a static postition we use them as part of our sector rotation strategy They are a good addition to the list of candidates to use because they are not very correlated to the overall market, and the tend to trend fairly well. They will often make a big move when the rest of the stock market is in a funk. The downside of holding these oil stocks is that when they start to trend down the drawdowns can be breathtaking. (Take a look at the chart of FSESX in 1998 to refresh your memory, a more than 50% drop in one year.)

Sector mutual funds that invest in energy and oil related stocks are fairly common. Fidelity has several of their Select Funds that invest in energy related stock, including

  • Select Energy
  • Select Energy Services
  • Select Natural Gas
  • Select Natural Resources

These mutual funds are a good choice because they have a minimum holding period of 31 days, so if the market moves against your for some reason, you can get out relatively easily.

The way to invest in oil stocks for many is to use exchange traded funds. ETF’s that invest in oil related areas include:

  • OIH - Oil Services HOLDRs
  • PXJ - PowerShares Dynamic Oil
  • XES - SPDR S&P Oil & Gas Equipment & Services
  • XOP - SPDR S&P Oil & Gas Exploration & Prod
  • OIL - iPath S&P GSCI Crude Oil Tot Ret Idx
  • IEO - iShares Dow Jones US Oil & Gas Ex Index
  • IEZ - iShares Dow Jones US Oil Equipment Index

As you can see, with ETFs you can narrow your focus to a small group of specialized oil stocks, or broaden it to the wider sector. But all of these mutual funds and ETFs give you a way to invest in oil stocks without the risk associated with some of the smaller players in the industry.

Filed under Asset Allocation, Sector Rotation

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