Energy is crashing! Feeling bullish? Here's an easy way to invest

The energy debate rages on as oil and gas futures bounce around with 30% corrections. Which side of the energy debate are you on? Bears say that oil and gas prices are coming back down to earth. Speculators and hedge funds bid them up, global demand is slowing and alternative forms of energy will soon replace the fossil fuels we’ve come to depend upon. Bulls argue that oil and gas supplies are dwindling at the same time that the emerging market economies (China, India, Brazil and 20 others) need more. As their middle class population builds they too will want cars, air conditioning and electricity and demand will increase. Most oil reserves are in countries with unstable governments and when geopolitical events get ugly, prices tend to skyrocket.

I’m a long term energy bull — 10% of my money has been in energy stocks for the last several years and today I maintain that allocation for two reasons. First, I believe in five years, oil and gas prices will be hhigher than they are today. Second, owning energy is a great hedge against other asset classes like stocks, the US dollar, and inflation.

No one knows which way energy prices will go next week or month so I continually rebalance my portfolio. As my energy stocks rise, I trim them and when they fall, I add to them. If my portfolio goes to 12% energy, I sell them back down to 10% and vice versa.

Now comes the easiest part – which stocks do I pick? Easy you say? Yes – because I don’t worry about stock picking due to a miraculous new invention I’ll discuss below. I own three energy stocks:
the U.S. Oil & Gas Exploration & Production Index (NYSE:IEO), the U.S. Oil Equipment & Services Index (NYSE:IEZ), and S&P Global Energy (NYSE:IXC). Through these three stocks, I own about 200 energy stocks in precise allocation percentages to parts of the energy sector, weighted according to my own preferences – 60% is in IEO, 30% is in IEZ and 10% is in IXC. Why pick stocks when I can own them all? Here’s what I mean.

The 62 stocks in IEO are engaged in the exploration for and extraction, production, refining, and supply of oil and gas products. Through these companies, I own oil wells and acreage where there are natural gas resources. The top 10 holdings of IEO are: Anadarko (NYSE:APC), Apache (NYSE:APA), Chesapeake (NYSE:CHK), Devon (NYSE:DVN), EOG Resources, (NYSE:EOG), Noble (NYSE:NBL), Occidental (NYSE:OXY), Southwestern Energy (NYSE:SWN), Valero, (NYSE:VLO), and XTO (NYSE:XTO).

The 55 stocks in IEZ supply equipment or services to oil fields and offshore platforms (drilling, exploration, engineering, logistics, seismic information services and platform construction). Through these companies, I profit from the high demand to drill more wells, build and service the equipment and pay for services. Because the energy companies are making more money, so do their service providers. This basket includes Baker Hughes Intl (NYSE:BHI), Cameron Intl (NYSE:CAM), Halliburton (NYSE:HAL), Nabors (NYSE:NBR), New Natl Oilwell Varco (NYSE:NOV), Noble (NYSE:NE), Schlumberger (NYSE:SLB), Smith Intl (NYSE:SII), Transocean (NYSE:RIG), and Weatherford (NYSE:WFT).

IXC is a basket of 77 stocks with about half in foreign stocks, including the largest global energy companies that own everything from oil reserves, to refineries to retail distribution. Through IXC, I own British Petroleum (NYSE:BPN), Chevron (NYSE:CVX), ConocoPhilips (NYSE:COP), Exxon Mobil, (NYSE:XOM), Petroleo Brasileiro (NYSE:PBR), Royal Dutch Shell, (NYSE:RDS.A), and Total (NYSE:TOT).

IEO, IEZ and IXC are actually Exchange Traded Funds (ETFs), which are unique index funds. They trade all day on the stock market just like any stock – IBM, Microsoft or Ford. You can buy them at any discount broker for $5 – $10 per trade. And just like any stock, when you sell them, you pay long or short term capital gains.

You probably don’t know about ETFs because Wall Street brokers and financial advisors don’t want you to because they can’t charge you fees on them. Hedge funds, wealthy families and elite institutions use ETFs routinely. They save a fortune over mutual funds because they aren’t paying a manager to “beat the market” by selecting the best stocks. Instead, you are paying the ETF provider a fee to run their computer models in order to maintain the stock basket. Its also proven that mutual fund managers rarely beat the market anyway – so why pay their crazy fees?

If you divided up a $10,000 investment in energy into IEO, IEZ, and IXC, you’ll pay fees of only $48 per year compared to $150 – $200 if you used similar mutual funds. And you will always do as well as the energy sector averages — no better, but definitely no worse. On average, mutual fund fees are 6 times greater than ETFs. I also pay less in taxes. That’s because buying and selling positions to beat the market generates taxable income. So it’s important to look at yearly turnover in a fund. These ETFs have 10% yearly turnover in their holdings versus 70% for the average mutual fund.

You might think that you or some professional money manager will be able to pick stocks and beat these indexes, but it’s proven over and over again, that picking stocks and trying to time the market is generally a fool’s game. Stock pickers who think they can pick energy stocks consistently over five years and beat the averages after their fees have statistics against them. If you think you can, then you should be wearing a wizard’s hat and a magic wand while you’re making your investments.

Are you bullish about energy? Then invest with ETFs and leave the stock pickin’ to T. Boone Pickens!