Oil is on sale! With such low prices, our client Marcus Junius Brutus the Younger has decided that now is the time to buy. But, wait a second – how exactly does one invest in oil?
This is the exact question that Brutus wrote to us about. (Actually, this question came up only after Brutus had made his oil investment – but we’ll get to that in a second.) Like many of you reading this post right now, Brutus had noticed that prices at the pump are at a substantial discount. And being no spring chicken, Brutus knew what was in store: an eventual return to normalcy, with gas prices of $4.00 a gallon.
Always eager to take advantage of an opportunity, Brutus writes in to say:
I think it’s a good time to get into oil investments, so I just purchased 100,000 shares of the “Ten-Times-Leveraged-Petro-Inertia” fund. I should be able to double my money once gas prices go back up over the next couple of years.
While the merit of a petro-chemical investment strategy is up for debate, the merit of utilizing Brutus’s particular fund is not in contention. Before we delve into why Googling “oil fund” usually does not lead to the best investing idea, let’s discuss how to invest in petroleum.
[big_title2]Investing in Petroleum[/big_title2]
Just in case you did not know this, hoarding physical oil is not an option. So, if you were planning on filling the family swimming pool with this currently discounted commodity, think again. Unlike other commodities (like gold which you can take physical delivery of, for storage in your home safe, basement, or under your bed), oil investment options are much more limited.
Despite the restriction on storing this chemical compound yourself, there are several mediums for investing in the petrochemical:
- Purchase shares of a corporation (stock) in the business of producing oil
- Purchase shares of a partnership in the business of transporting oil
- Purchase futures contracts on crude oil
- Purchase a mutual fund that does any, or all, of the above
Like all investments, there is substantial risk. This is especially the case when leverage (futures contracts) are involved. Further, (we think that) not all oil-investing options are good ones, and that some of the options for investing in oil are better than others.
[big_title2]Using the Wrong Type of Investment[/big_title2]
For Brutus, his particular fund pick will most likely not generate the investment returns that he is looking for. This is because the fund that he choose is not designed to be held in excess of one day. You read that correctly. That is, this leveraged fund is designed specifically for day traders – those investors who hold investments for hours, minutes or even seconds – not days, weeks, months, or years. This is the case because this particular fund does not track price movements of the specific oil index it’s designed to follow accurately outside of one day.
This little tidbit of knowledge is not proprietary information. In fact, it’s readily available for view, in bolded font, on the front of page of the fund’s prospectus. (A prospectus is a legal document describing a particular investment.) Here are some direct quotes from the prospectus:
- intended to be daily trading tools for sophisticated investors to manage daily trading risks
- performance over different periods of time can differ significantly from their stated daily objectives
- may not be suitable for investors who plan to hold them for a period other than one day
- you will suffer significant losses in the fund even if the long-term performance of the applicable Index is positive
In short, do some research before throwing your retirement nest egg at an investment idea (be it oil, or anything else). That research can include running your ideas by your fee-only Certified Financial Planner. Without the conflict of interest that comes from the desire to sell financial products for a commission, a fee-only Certified Financial Planner® (CFP®) works for you as a fiduciary!