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Add Spark to Your Retirement Portfolio with Self-Directed IRAs in the Energy Sector

written by: Shobha Sriram•edited by: Jason C. Chavis•updated: 6/28/2011

Most investors find sector-specific investments risky. However, with the surge in oil prices, it may be wise to explore energy investments to balance your self-directed IRA. Recent government policies to boost renewable energy provide lucrative investment options in the sector as well.

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    What are Energy Investments?

    Energy investments were practically unknown to the investor looking to protect his retirement portfolio until recently. Even the passive investor is waking up to the volatile consequences of a series of disappointing economic events over the past few years. Investors need to have a complete understanding of the benefits of investing in energy assets through his or her self-directed IRAs.

    Though a self-directed IRA provides you the freedom to select, invest and manage your portfolio, choosing a combination of direct and indirect energy investments makes your IRA portfolio powerful and balanced. Such a portfolio benefits from reduced taxes and asset protection. For example, you can avail tax benefits provided by the government, if you invest in renewable energy through your self-directed IRA.

    Energy investments can include investing in oil, natural gas, coal and renewable energy sources like solar energy, wind, or biomass etc. Investing in energy can be accomplished either directly or indirectly. Through stocks and mutual funds, these investments are considered indirect whereas investments through limited partnerships or lease agreements take the direct route.

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    Investment Options

    oil and gas drilling 

    In the current economic environment where the price for a barrel of oil reaches higher levels everyday, investment options vary from picking the right oil stocks to investing in long-term master limited partnerships. Energy stocks that benefit directly from oil prices rising are few and far between. Favorable energy stocks may include companies that engage in oil transport or other large players, which can weather sudden drops in crude prices. If you are not one of those prudent stock pickers, sector-specific ETFs and mutual funds are the next best options. These are generally long-term investments that provide diversified exposure to the energy economy.

    However, if you want to invest in profitable companies that are not affected by volatile oil prices, you can invest in master limited partnerships (MLP). One of the best examples of an MLP is a pipeline operator. Revenue generation is based on the volume of petroleum products transported through their pipelines. Thus, independent of oil price spikes, they provide stable profits as long as the oil continues to flow. MLPs are traded publicly on the US stock exchange. They provide dividend income and act very well as an inflation hedge.

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    Protect Your Portfolio

    The key benefits of adding energy investments to your self-directed IRA includes strong returns, risk diversification and inflation protection.

    Strong returns: Due to the unprecedented rise in oil prices in the past few years, annualized returns from energy players have been increasing year after year. In general, returns from direct energy assets have exceeded returns from traditional investments in stocks, bonds and mutual funds.

    Risk diversification: Energy has a low correlation with stocks and bonds. This means that energy assets reduce volatility in your retirement portfolio returns. However, the presence of direct energy assets alone does not eliminate portfolio risk. Only in conjunction with other assets and as part of diversified portfolios, can energy assets protect against adverse market conditions.

    Inflation protection: By providing larger returns with lower risks during high inflation, direct energy investments may protect your retirement portfolio. In contrast, the energy assets give low returns and high risks during low inflationary periods.

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    Going Green – The Road Ahead

    wind turbine 

    In the past few years, serious concerns over the continual depletion of non-renewable energy sources have led to the rise in sourcing alternative energy like biomass, wind power or solar energy. Though the up-front costs of a renewable energy project are huge, the project ultimately turns out to be cost-effective considering the perpetual availability of the natural energy source. For investors, the opportunity to invest in green energy, which is becoming the environmental and economic future, provides potentially high and ethical returns.

    Biomass consisting of forest residues, wood chips and garbage is converted to release electrical or heat energy. Biomass Power Association states that this type of power generation for electricity has grown by 25 percent over the last decade. In order to minimize greenhouse gas emissions, Dow Chemical has invested in a biomass cogeneration unit that provides process steam. However, the major difficulty with the biomass sector is its huge transportation costs. To tackle the issue, a small power plant, Iberdrola Renewables has set up its facility next to its customer, a paper mill in Tahoma. Xcel Energy, a major American power company, also produces energy technology such as biomass power systems. Companies such as Iberdrola Renewables and Xcel Energy could be examples of the growing future of the sector.

    Wind energy projects involve converting wind power using windmills to produce electricity. With an annual growth rate of over 30 percent in the last few decades, particularly in Europe, wind energy is the fastest growing renewable energy next only to the biomass energy. Companies such as Vestas Wind Systems have increased their wind turbine capacities to meet the huge demand for wind energy.

    Many companies are adapting to energy-efficient business practices. As businesses increasingly continue to demand renewable energy, opportunities for green energy have grown immensely. For example, Google’s $400 million investment in green energy has impacted its stock price positively. Likewise, GE Capital, ConocoPhillips and NRG Energy stocks have seen a positive rise in their stock prices after announcing plans to form a joint venture to invest $300 million in new energy development.

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    Image credits:

    • Oil and gas drilling via
    • Wind turbine via turbine