Commodities are physical goods, such as livestock or precious metals, that can be used as-is or to make other goods. They are becoming a more mainstream investment choice. It can make sense to include them in your long-term portfolio. But you should know what to expect.
- You can invest in commodities directly, through mutual funds and ETFs, or with futures.
- Use commodities for growth potential, diversification, and hedging against inflation.
- Their risks include high levels of volatility, especially when using complex instruments like futures contracts.
The Basics of Commodities in a Portfolio
There's a big difference between investing in commodities and speculating in them. You may be thinking of opening a commodity trading account and trading futures contracts if you want to invest in this way. But opening a trading account with no track record, no training, or without a plan is speculation rather than investing.
It often takes a bit of time, money, and effort to learn how to trade and to make money over time. You should only use the money you can afford to lose, not the money you depend on, for self-directed commodities trading until you know the ropes.
You might include commodities as one asset in a long-term portfolio that you intend to use for a future goal, such as income to help you fund your retirement. You would put a certain portion of your portfolio in commodities using this approach. You could choose to put 5% to 15% in commodities. But take care to choose those that will still be around in 20 to 30 years.
How to Invest
You can invest directly in commodities. This approach involves buying the goods yourself. Or you can invest in mutual funds. Gain exposure by buying mutual funds that are made up of the stock of firms that deal with certain commodities.
You might also invest in futures contracts or exchange-traded funds (ETFs). This involves trading futures contracts (agreements to trade for a set price and at a certain date in the future) or ETFs that include commodities or commodity indexes. This approach can be the most volatile unless you get the help of a professional to trade managed futures on your behalf through an account.
Use only risk capital that you can afford to lose in a self-directed commodity trading account if you're inexperienced.
The Benefits of Adding Commodities
A commodities portfolio comes with quite a few advantages. The price of commodities often goes up as demand increases. It goes down as supply increases. This type of portfolio may reward you with higher returns than you could have achieved through an asset allocation of stocks and bonds, depending on the market.
Commodity prices won't always move in tandem with the stock market. Goods can't go bankrupt as companies can. Having a portion of your portfolio in commodities versus entirely in stocks and bonds allows you to hedge against sharp declines in the stock market.
A commodities portfolio may help you weather inflation without the same losses as one made up of just stocks and bonds. Commodities have performed well during inflationary periods in the past, even as stocks and bonds have lost value.
The Risks of Adding Commodities
Commodities tend to be more volatile than other choices because their prices are dictated by supply and demand. This volatility may mean that when you lose money, you lose a lot.
A traditional mutual fund may include securities spanning a wide range of industries. But a commodity fund may contain less diverse securities that only give you exposure to a few industries.
There's no promise that the investment will perform well just because a commodity is in demand. Opening a commodity account and trading futures contracts on your own should not be part of a strategy for building a retirement portfolio that you'll depend on for future income.
Options for Commodity Investments
You might think about a few types of investments to gain exposure to commodities in your portfolio.
Managed futures let you trade in the futures market through a money manager. They might be one of the best ways to invest in the commodity market. Your money is often placed in a separate account that's managed by professionals who invest in a number of commodities that can earn a decent return over a span of years. They're not correlated with other investments like the stock market. This offers a strong degree of diversification.
These futures fund managers are often guided by a trend-following approach. This is a good way to catch large movements in commodity prices, whether they're up or down. Some investors even diversify within futures funds in their managed accounts. It may make sense to invest in a trend-following fund and a fund that trades the ranges in commodities.
You can also invest through commodity ETFs. There's a variety of ETFs that invest in diversified commodities or in businesses that deal with them. Some only invest in a single commodity. Others invest in a particular commodity sector.
You can tailor your investment to what makes the most sense for you. It's best to try for a widely diversified group when you're choosing these ETFs for the long term. Commodity stocks have been one of the more popular choices over the years. Gold-mining stocks are among the favorites.
The Bottom Line
Commodities can help you diversify a long-term portfolio. They may increase your returns if you know the difference between speculation and investments. You should know the rewards and risks.
Opening a commodity trading account without a plan should be thought of as speculation. Only risk capital should be used. Investors seeking long-term growth should allocate a portion of their portfolios to commodity investments that will still be around in a few decades. Investing in commodity funds through managed commodity accounts affords the chance to gain exposure at less risk than performing commodities trading on your own.
NOTE: The Balance doesn't provide investment services or advice. This information does not consider the investment objectives, risk tolerance, or financial circumstances of any one investor. It might not be right for all investors. Investing involves risk, including the loss of principal.