Oil Mutual and Index Fund Galore, What to Do?

Following up on our post below, we would like to give you an idea on how exactly to choose mutual and index funds so you can benefit from rising oil prices. With literally hundreds of oil exposed funds, you have a great array of unique fund characteristics to choose from and that need to be taken in to consideration.

Before making your final decision to invest in a specific fund, you should become familiar with, and observe the following unique fund characteristics:

1. Holdings & Diversification - To really benefit from rising oil prices you should choose a fund with the majority of it's stock holdings in direct oil/petrolium refinery and gasoline companies (Exxon, Shell, etc..), preferably greater than 75%. A fund's holdings can be viewed by examining its prospectus, website, or through almost any other financial website such as Yahoo Finance, Bloomberg, MoneyCentral, and others. We suggest choosing a fund with less than 10 seperate oil stocks, because above 10 the benefits and risk-reward ratio from diversification greatly decreases, and therefore the systematic risk increases.

2. Turnover - This is another area were you need to be aware of your risk tolerance. A funds turnover is simply the amount of times its holdings change throughout the year. A higher turnover in general means the fund is more active, seeking higher gains, and is thus more risky. A lower turnover ratio (index funds) means the fund is more passive, and less risky.

So what is high and low turnover?

For index funds anything above 10% can be considered high and 5% should be considered low. Mutual funds are different than index funds because their turnover ratios can vary greatly, depending on how active they are and the fund's size.

For a small cap mutual fund, anything greater than a 200% turnover ratio should be considered high and 50% low. For mid and large cap mutual funds, 150% should be considere a high turnover ratio and 20-30% a low ratio. Also, if you would like to go by the average, the average turnver ratio for a mutual fund is 90% and the average for an index fund is near 5%.

3. Expense Ratio - Fees are among the most important of these 4 fund aspects. For a mutual fund you should be willing to accept higher fees than an index fund, because mutual funds on average are more active and outperform index funds. For a mutual fund an acceptable fee rate would be 1% or lower, and it should be .5% or lower for an index fund.

4. Minimum Investment - Mutual and Index Funds can have many different minimum investments. Therefore, be sure to find a fund with a minimum investment you are comfortable with and this minimum investment conforms to your overall investment strategy and portfolio diversification. For example, say your total portfolio of all your investments is $50,000, you are a conservative investor and may want to have 5% exposure to oil, so therefore you would find a fund with a minimum investment not greater than $2,500.

You should first start with finding a group of funds that would accept your investment size, weed out the funds which have too large of a minimum investment. No need to waist your time analyzing a fund which will not accept your investment size. Second, check the expense ratio, then holdings and turnover ratio.

Be sure you are always aware of your investor profile and to choose a fund only if its characteristics match your investor profile. In brief, when choosing an oil index or mutual fund you should look for a low expense ratio in general, a relatively low turnover ratio if you are a conservative investor and a little higher turnover ratio if you are moderate to aggressive. Also, look for a fund which has the majority of its holdings exposed to direct oil refining and gasoline companies.