With a broad-based investing strategy, you don't necessarily have to look for sectors that will outperform the overall market. But if you're willing to take the additional risk that comes from making a concentrated investment in a particular sector, there are a number of ways to do it.
For instance, amid all the news about struggling automakers, up-and-down financials, and an economy that's still trying to hit bottom, you may not have noticed that the bust in energy appears to have run its course. But with energy prices starting to head back up, you won't be able to ignore what's going on in the oil patch much longer.
Quietly, things are looking up for energy companies. Gasoline recently rose beyond $2 per gallon on average, while oil prices have moved convincingly past the $50-per-barrel mark in recent weeks.
If you want to take advantage of this possible trend shift, you'll find a number of ways to participate. Which one's best for you?
Mix and match
Perhaps the most obvious way to try to profit from a coming oil boom is to buy shares of a few individual companies in the industry. But higher energy prices don't necessarily affect every energy company in the same way. While oil producers like BP
Because of the dangers of picking individual companies, you may want to make a more diversified investment in energy. Here, too, you have a number of choices.
1. Energy sector funds and ETFs
To get stock exposure in companies throughout the energy industry, ETFs and sector funds are perhaps the most efficient method available. The Energy Select SPDR, for instance, includes big players like ExxonMobil
Similarly, conventional sector mutual funds like Vanguard Energy also provide a low-cost entry into the industry. Although each fund takes a slightly different angle on how it allocates money among different stocks, you can generally count on seeing your investment move in line with the overall energy sector. Being cost-conscious is critical, though, to eke out the best returns.
2. Closed-end funds
Less well-known are energy closed-end funds, which span a wider range of energy-related investments. Some closed-ends, such as Tortoise North American Energy, own a number of limited partnership investments. Others, like Petroleum & Resources, stick with top stocks like Chevron
The benefit of closed-end funds is that you can sometimes pick up shares at a discount to net asset value. Petroleum & Resources, for instance, currently trades at about a 12% discount, meaning you're paying only $0.88 for each dollar's worth of the fund's holdings.
3. Exchange-traded commodity trackers
Sector ETFs and funds typically own interests in energy companies. But if you want pure exposure to the price of crude oil or natural gas itself, then you'll want something else.
Increasingly, brokers will let you invest directly in commodities. For those who are unfamiliar with how futures contracts work, however, this can be a daunting prospect.
An easier alternative is to use exchange-traded trackers like United States Oil Fund. This ETF invests its assets in futures contracts, letting investors buy and sell ETF shares on the open market just like any other stock. A similar fund exists to track natural gas futures as well. Although these funds may have significant tracking error, because of differences in pricing between futures contracts, the funds do typically move up when energy prices rise, and drop when they fall.
Pick your play
Which of these vehicles will best help you build a position in energy depends on exactly what you believe will happen in the energy markets. Given the amount of information available on energy companies, funds and ETFs that own stocks may be the easiest for investors to understand. Yet if those companies can't take full advantage of rising commodity prices, then investments linked directly to oil and gas prices themselves may perform better.
When the economy recovers -- and people increasingly seem to believe it's on its way -- you can expect the reprieve consumers have gotten from the spike in energy prices last summer to end. If that happens, those who invested accordingly will reap rich rewards.
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Fool contributor Dan Caplinger thinks energy has some good prospects. He owns shares of Petroleum & Resources and Chesapeake Energy, which is a Motley Fool Inside Value selection. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy is high-energy.