Learning how to invest in oil using an IRA can help one grow their wealth in preparation for retirement. Here’s what interested investors should know about investing in oil inside your IRA.
In this article:
- Why Invest in Oil
- Types of Oil Investments
- How to Invest in Oil in an IRA
- Other Noteworthy Options to Increase Net Worth
How to Invest in Oil for Wealth Appreciation and Retirement Protection
Why Invest in Oil
Regardless, investing in oil in an IRA remains a legitimate option to reduce your tax liabilities and reach your long-term investment goals.
Why is learning how to invest in oil essential for those with individual retirement accounts (IRAs)?
One primary benefit is that oil is a limited resource. Resources like this can add value to your portfolio since they offer a level of stability to help with the complexities of an investment strategy.
Now, there is no way to necessarily predict for sure when oil will have a high rate of return. However, looking at historical oil prices and up-to-date rates can help you to plan your investment.
Oil is a volatile commodity, however, with crude oil prices frequently going up and down.
Because of this, oil investments are often more suited for long-term investors. The good thing is that it adds balance to your portfolio.
Types of Oil Investments
Investors have different ways to invest in oil. Your options can help you decide on the strategy that works with your goals.
The first method of investing in oil is through exchange-traded funds (ETFs). An ETF tracks oil futures and stocks.
It trades like a stock but has more than one oil stock in the fund. The price of the fund increases and decreases throughout the day to reflect trades.
The advantage of an ETF over other funds is its low fees. It is also a liquid investment — you can sell the ETF when you no longer want to hold the fund.
A sector ETF differs from a basic ETF. The sector ETF buys stocks in oil companies and builds up a fund.
As an ETF, it has a low fee. The advantage is the diversification it brings to the portfolio.
A sector ETF buys multiple companies in the energy sector so you have fewer complexities in your IRA account.
You can buy future contracts for oil. Futures contracts mean you pay a price now for a contract to buy the stock or ETF at a later time.
You take a bet on the rise or fall of the company or the group of companies.
A downside of futures contracts is they provide a short-term way to make or lose money. You want to use caution and discuss the complexities with a financial planner or advisor before you buy a contract.
3. Stock Market
Buying individual oil company stocks is the final way to invest in your IRA account. Oil stocks differ based on the company and location. The price rises and falls to reflect the business.
If the company has a problem, then you’ll see a lower price. If the cause of a dip relates to factors outside the company’s control, then it might be a good time to buy your stocks.
The advantage of stock investing is its liquidity. You buy and sell when it fits your goals.
You pay a one-time fee for a trade as well.
The downside of buying individual stocks is volatility. Price may rise and fall significantly within a single day.
If you want to invest in this method, you might want to consider buying from several companies to diversify your portfolio.
How to Invest in Oil in an IRA
Now that you know the different options, it is time to learn how to invest in oil when you have an IRA.
1. Evaluate Your Options
The first step is to evaluate your options. You can buy complex investments like oil stocks and futures contracts.
You can also opt for diversified ETFs to simplify the process. Then, look at your long-term goals:
- Will you benefit from exchange-traded funds?
- Do you want a higher-risk, higher-reward option?
The key is looking at the options and finding the strategy that works with your goals.
After you have a clear idea of your options, research the details. If you decide to buy a fund, ask yourself:
- What stocks are in the fund?
- How are those stocks doing?
- How much are the monthly or annual fees in the fund?
If you decide to buy stocks, find out what the company does and where they work. Look for details about the plans for growth.
Does the company have a long-term plan? Is the company stagnant?
You also want to make sure you know the cost of a trade before you make a change.
Once you decide if you want to invest in oil stocks, futures contracts, or diversified ETFs, you can begin the process of investing.
Investing in Oil Futures
If you opt to invest in futures, use a commodities broker. With the broker, a contract will be created indicating the purchase of oil with a future date.
As previously stated, this is a more complex investment option and you should do extensive research about the industry to learn about potential pros and cons.
Investing in Oil ETFs or Stocks
For ETFs or buying stocks, like in an oil company, for example, you can work with your IRA custodian or a financial advisor on the investment. With their assistance, you can select the stocks or ETFs, purchase them, and confirm your transaction.
Depending on the type of investment, it may take a few hours or a day to confirm your trade. Stocks usually confirm your trade within minutes.
Other Noteworthy Options to Increase Net Worth
All the strategies above can help you generate passive income and diversify your assets, but you can also make more specific oil and gas investments. These include the following:
1. Master Limited Partnership
Also known as MLP, this is a publicly traded limited partnership, and it’s traded in national exchanges. Companies, usually natural gas and oil, participate to boost their cash flow and capital.
In turn, an investor can earn money once the business generates income. The structure of MLPs requires it to pass on, or make distributions of a portion of its income, including dividends, to its investors.
You can use your IRA to invest directly in an MLP and this is ideal if you want to own a share (referred to as “units”) of the business. People who invest in MLPs are called unitholders, while those who buy into it are called limited partners.
As one of the oil-related investment opportunities, this allows you to maximize tax incentives since you don’t pay taxes until the company makes distributions. You can also reduce your tax liability with the depreciation expense and deductions taken by the business.
Note, though, keeping this in your IRA may make you liable to pay tax since the IRS can treat this as unrelated business tax income (UBTI).
What is unrelated business tax income? It is income not related to the purpose of your account or nature of business.
2. Exchange-Traded Notes
Exchange-traded notes (ETNs) are also one of the strategic ways of how to invest in oil inside your IRA.
Unlike ETFs, ETNs are senior debt securities the bank issues. It serves as a promise by the issuer you will receive income up to the full value of the index once it decides to sell the ETN.
With ETNs, you can defer paying your capital gains tax (CGT) until the sale. This makes the instrument attractive to long-term investors using their IRA.
It also doesn’t carry the same problems as an ETF, such as tracking errors. This refers to a significant difference between the actual return and the underlying index.
The index can include Crude Oil Total Return Index, which tracks the performance of energy companies in the market. It gives you a chance to learn how to invest in crude oil.
The downside of this oil investing strategy is this is an unsecured investment. The bank doesn’t guarantee you will receive any return unlike bonds, which have fixed interest payments.
It means if the bank suffers bankruptcy, you won’t be able to get your investment or return. You can learn to protect your assets by monitoring oil exporting and importing markets.
Keep track of the value of a barrel of oil, as well as inflation and global demand. This way, you can have a better idea of the performance of the market.
Most of all, if you want to do ETN, pick one from the most reliable banks, especially those with a history of these types of transactions.
3. Oil Wells
You can also learn how to invest in oil wells, which are areas where gas companies dig and retrieve oil or petroleum for selling.
One of the significant advantages is you can invest over a long period. In fact, it can be as long as 20 years.
Using your self-directed IRA, you can consider putting your money during the exploration stage.
The buy-in for the accredited investors is low, but this is also the most complex phase as the dig may only result in a dry hole.
If you have considerable savings in your self-directed IRA, one of the investment strategies you can consider is to contribute during the development phase. It has lower drilling costs, so you and the business can maximize returns.
Once you get into the operation phase, expenditures are already small. Depending on the performance of the barrels of oil and the company income, you may look forward to steady cash flow every month for the next two decades or so.
4. Diversification Under the Same Company
You already know how to invest in oil stock (including energy stocks) and why you need to know the best oil company to invest in. Usually, though, when you consider this strategy, you can put your money only on oil.
What you probably don’t know is you can make oil and gas investments in a company with a diversified portfolio. It may include mining companies that dig the ground not only for precious metals but also for petroleum and fossil fuel.
This way, if oil doesn’t perform well, you may still expect returns from other commodities such as precious metals.
When you know how to invest in oil, you have a chance to diversify into an interesting commodity. The key is finding the right way to purchase it. By working with a facilitator and discussing your options, you can purchase oil stocks or oil futures that fit your long-term goals.
What do you want to learn about how to invest in oil? Let us know in the comments section below.
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Editor’s Note: This post was originally published on October 17, 2018, and has been updated for quality and relevancy.