How to Invest in Different Types of Natural Resources

Twisty forest paths

Our earth's natural resources are not unlimited, and much profit is to be had from their development, use and distribution. There are many different avenues available to investors seeking to profit from oil and gas, alternative sources of energy, timber, coal and other ores and metals.

Instructions

1. Decide what type of natural resource that you want to invest in. You can choose from oil and/or natural gas, coal, timber, other ores and metals, precious metals (although these are usually considered to be a separate asset class) and alternative sources of energy such as wind and tidal power, ethanol and hydrogen fuel cells.

2. Invest directly in natural resources investment programs through limited or general partnerships. These vehicles pass through a prorated portion of the investment profits as partnership income (or losses). You will receive a K-1 form from the partnership at the end of the year detailing your income and expenses, which you must report on your tax return. There are partnerships available for virtually every kind of natural resource investment under the sun.

3. Invest in working interests for even more direct participation in natural resource ventures. This type of arrangement gives you direct ownership of all or part of a project. You have direct liability for all losses incurred in the project and must report all income on Schedule C of Form 1040. This means that you must pay self-employment taxes on any income earned below the Social Security Wage Base.

4. Look to mutual funds and unit investment trusts (UITs) to increase diversification and tax advantages. There are many mutual funds available that invest in a wide variety of publicly traded natural resources development and distribution firms and partnerships. UITs can provide passive management and favorable tax treatment if the term of the trust exceeds one year. Individual stocks and options can be appropriate if you have carefully researched specific companies and are willing to take more risk to profit from a substantial rise in the price of the stock. You will reap standard dividend and capital gain income from investments in this category.

5. Purchase futures contracts on the commodity or commodities of your choice if you are a high risk taker, or else if you own quantities of the actual commodity and wish to hedge your position. You can buy futures either online or from a futures broker and will reap capital gains or losses from your transactions.

Tips & Warnings

• Natural resources investments are cyclical in nature and have followed historical economic patterns. But investments in this sector are, by definition, considered to be riskier than broader-based investments. Investors should thoroughly understand the risks inherent in this sector.

Resources

• Morningstar's website