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Why You Should Consider Investing in Commodities

By Edited May 4, 2016 0 0

Commodity investing has become increasing easy due to a number of products such as commodity ETFs, ETNs, and mutual funds that have appeared over the past few years. Here is brief overview of the reasons that you should consider investing in commodities as part of your investment portfolio.

Historically commodity investing can enhance long-term investment returns

According to a study by two Yale business professors, over periods of time including a decade or longer, allocating a portion of your portfolio to commodities along with more traditional investments (e.g., stocks, bonds, etc.) can enhance returns compared to a portfolio without such an allocation.

Commodities are often negatively correlated to stocks

Returns on commodity futures often negatively correlate to returns on stocks. That is, commodities may be a good investment for periods when stocks do not offer good returns. This is obviously a generalization based on historical correlations, but it does indicate that commodity investments may help diversify a portfolio and smooth out returns over periods of time.

Commodities "bet the market" and not an individual company

One advantage of commodities investing is that by investing in commodity futures, you are not necessarily making bets on the management team or other factors related to an individual company. In addition, companies can go out of business, but the price of a commodity itself almost never goes to zero. (That is not to say that an investment in commodities cannot go to zero! It can.) But it is a different type of bet.

New Investment Products Make Commodity Index Investing Simpler

One reason that commodity investing has been overlooked by individual investors is that, until very recently, it was more difficult for the individual investor to invest in commodities through a regular stock brokerage account. Fortunately, a number of new ETF and ETN products have made a wide array of commodity investments available to individual investors. This includes a number of broad-based commodity indexes that offer diversified allocation to this asset class.

A few more things to learn

There are a few things that you should investigate fully before investing in commodities. First, many commodity ETFs and ETNs invest in commodities futures contracts, which may or may not always perform in line with changes in price of the underlying commodities. Put another way, there are dynamics in the commodities futures markets than could mean that the performance of a particular commodity ETF will not exactly track the performance of the underlying commodity. As with any investment, you need to do due diligence to understand the unique dynamics of commodity ETFs. It is a different animal than just buying shares of a single company stock. So although it is very easy to purchase a commodities-based ETF through your stock brokerage account, that shouldn't absolve you about learning how futures market impacts these ETFs. I can share from personal experience that I've made poor investments in early commodities ETFs because I didn't do enough homework to understand the investing strategy of the particular ETF.

Also, many commodity ETFs and ETNs have different tax implications than traditional stocks and mutual funds. Often two commodity ETFs which seem similar on their face differ in terms of year-end tax implications. Consult with an advisor about tax implications if need be prior to investing.

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