About Oil ETFs
The new way of investing in oil is to invest in an oil ETF or exchange traded fund. One look at the price of gas when fueling up for the weekly commute should provide great incentive for most investors to consider oil ETFs. After all, we all have to have gas and oil, right? With the skyrocketing of gas prices, ETFs are performing well and are a sound investment for a number of different investors. With an oil ETF, you do not actually own oil. Instead, the fund is made up of forward contracts, futures, and options for oil, gas, and petro-based fuels without the need to have an oil well pumping in the back yard.
An oil ETF allows the investor to invest in oil commodities without the risk and cash layout required to purchase a direct oil contract. The ETF works by pooling the dollars of multiple investors so that the smaller investor can participate in the losses or gains that follow the rise and fall of the price of oil.
How Does the Oil ETF Work?
The oil ETF is not a stock, since there is no “company” to buy into, but is traded very much in the same way that stocks are traded. Essentially, an ETF trades like a stock but is setup almost like a mutual fund. ETFs have a lower expense ratio than mutual funds, however, and are a more affordable alternative for the average investor. Mutual funds do not offer the flexibility of the ETF, although both are managed funds that can help to diversify an investor’s portfolio while hedging against volatility and risk. For long term investing, no investment exceeds the potential of the oil ETF. Most ETFs are traded on the stock exchanges and have their own ticker symbol.
Why Buy Oil ETFs?
One of the best things about buying oil ETFs is the simplistic nature of the trade. Purchasing individual company stocks in oil companies (and choosing which to invest in) can be time consumptive and risky. Even if you choose to invest in an oil index, there is another challenge to overcome: purchasing the equities in the basket to target a particular price. Commissions can make it difficult to achieve your objective. With the purchase of an oil ETF, you will make just one purchase that will save you commissions. The ETF is pre-bundled ahead of time, giving you automatic exposure to oil prices without the heavy research.
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Advantages of Oil ETFs
Investing in an oil ETF give the investor a tax benefit. Capital gains tax is not incurred until the fund sale, which gives the ETF a huge tax advantage over other types of investments, including mutual funds. Moreover, this type of ETF allows the investor to hedge their portfolios against risk while adding stability to the portfolio, even in uncertain market conditions. In fact, even for short-term protection, oil ETFs can be the answer.
Choosing an Oil ETF
When choosing the right oil ETF for your portfolio, professional help is advised. Your broker will best know your risks and can analyze the ETF options for you in a way that most investors cannot. Once you decide to invest in an oil ETF, you will need to decide in which category you want to put your dollars. Some ETFs are invested in oil direct through futures contracts, while others may invest only in the stock of oil companies and oil industry-related companies. You should also research each individual oil ETF to determine which the best is for you.
Best Oil ETFs
When considering an oil ETF, think about the following top-performers:
- United States Oil Fund LP (USO). Among all oil ETFs, USO is the most actively traded with nearly nine million shares in circulation. Even though USO is not the most efficient oil price tracker, it is super liquid for investors who make short-term investments.
- Pro Shares Ultra Crude Oil (UCO). This ETF is runner-up only to USO when it comes to liquidity and has around 4.5 million shares trading each day.
- iPath S&P Total Return (OIL). With around 3/4th of a million shares trading daily, this oil exchange traded fund tracks the Goldman Sachs Commodity Index.
Best Online Brokerage Firms For Oil Investing
Historically, only well-heeled or institutional investors traded in oil, but financial products such as oil ETFs have opened the door to smaller investors.
The ETF’s more affordable price, ease of use and liquidity make it a popular financial product and gives investors more ways to buy and sell this commodity.
Investors now don't need to overpay for oil ETFs and stock transactions. For trading oil ETFs we recommend OptionsHouse brokerage firm,
that charges just $4.75 for stock or ETF trade. Read full Optionshouse Review 2014.
Another popular option is one of the largest brokerage houses in the U.S. - Etrade.
This article was updated on 10/30/2014.