Derek, what’s the best way to make some money by investing in energy today?
The greatest investment opportunities tend to arise when there is the most perceived fear in the decision process.
We are all aware the price of oil has declined substantially from the summer of 2014 highs. This has prompted a decline in spending, notable job cuts and reduced forecasts.
As well, we’ve seen share prices of numerous oil and gas companies decline precipitously. So, before diving into energy investing, it’s best to consider your options and understand your risk tolerance.
First of all, no one is absolutely sure where the price of oil will be in the short term. At any given time you might find an analyst who believes the price will only go higher; yet another predicts coming declines.
The reality is there is no certainty, and from an investment perspective this is problematic.
If you’re focused on the short term, you are speculating and taking on substantial risk. On the other and, if you’re planning on a long-term investment, you will likely see higher energy prices in the future.
A longer time horizon of three-plus years should help eliminate some of the concern that prices will drop. Said another way, I don’t know what’s going to happen three to five weeks from now, but I believe that energy prices will be higher three to five years from now. An investment made today may be a successful one.
Whether you’re a short-term speculator or a long-term investor, you’ve made the decision to invest in the energy sector. Whether this is the right decision or not, there are a number of ways to go about it.
Your first option is to decide whether you want exposure to only the price of oil, or do you want to invest in the companies who operate in the sector.
If you want to profit from the increasing price of oil, you could do one of two things. You could buy a barrel, store it, and sell it back to the market at a higher point down the road. Alternatively, you could invest in an exchange traded fund (ETF) that tracks the price of oil.
ETFs are relatively inexpensive investment vehicles that focus on a specific sector or commodity. By investing in an ETF concentrated on only the price of oil, your investment returns will be generated by the price movement in oil.
The ETF is one way to get exposure, but be wary of what you’re actually invested in. Some ETFs use leverage and are intended for very short-term investments.
There are many ETFs to choose from; be sure to discuss your choice with a professional investment advisor before proceeding.
If you’d rather have exposure to the companies who operate in the sector, you need a strategy. For example, you may wish to diversify and reduce your risk by investing in multiple companies, or increase your risk and potentially your returns by selecting specific companies.
To take a diversified approach, you may again consider an ETF. There are ETFs that track the Canadian energy sector that would give you a weighting in many of the biggest companies in Canada. The benefit to this approach is you’re not overly exposed to a particular company.
You could also consider a mutual fund focused on the energy sector, whereby the fund manager is choosing companies they feel should profit the most.
If you plan on investing in select companies you should be fully versed on the potential upside and downside of each company. If prices do not improve, some companies may see declining share prices. Others will likely succeed for years to come but may not give you the full return you were expecting.
A diversified approach is probably the best and a professional can direct you accordingly.
Lastly, before rushing out to invest every last dime in the energy sector, consider the implications if you lost the money you plan to invest. Also, consider how long you are willing to wait to see favourable returns. Are there any other sectors besides energy that could do better?
There are many other factors to consider prior to investing. To make the most of your investment dollars consult with a professional to create a strategy that works for you.
Wealth Watch is written by Derek Fuchs, a wealth advisor with ScotiaMcLeod in Red Deer. It is provided for informational purposes only and any opinions contained in it are his own. Readers are urged to consult a wealth advisor for help with their personal investment circumstances. Fuchs can be contacted at firstname.lastname@example.org.