Opportunities and Risks of Investing in Commodities
Commodity Basics in the Portfolio
There is a significant difference between investing in commodities and speculating in them. You might consider opening a commodity trading account and trading futures if you wish to invest this way. However, opening a trading account without a business record, training, or a plan is speculation rather than investment.
It may take time, money, and effort to learn how to trade and make money over time. You should only use money that you can afford to lose, not money you rely on, for self-trading in commodities until you learn the ropes.
Commodities can be included as one asset in a long-term portfolio intended for future goals, such as income to help fund your retirement. You can allocate a certain portion of your portfolio to commodities using this approach. You might choose to allocate 5% to 15% in commodities. But be sure to choose those that will remain relevant for 20 to 30 years.
How to Invest
You can invest directly in commodities. This method involves buying commodities yourself. Alternatively, you can invest in mutual funds. Gain exposure by purchasing mutual funds that consist of stocks from companies dealing with specific commodities.
You can also invest in futures contracts or exchange-traded funds (ETFs). This involves trading futures contracts (agreements to trade at a set price on a certain date in the future) or ETFs that include commodities or commodity indexes. This method can be the most volatile unless you get help from a professional to trade managed futures on your behalf through an account.
Note: Only use risk capital that you can afford in your self-directed commodity trading account if you are inexperienced.
Benefits of Adding Commodities
A commodity portfolio comes with many advantages. Commodity prices often rise with increased demand and fall when supply increases. This type of portfolio may reward you with higher returns than you could achieve through asset allocation in stocks and bonds, depending on the market.
Commodity prices may not always move in tandem with the stock market. Commodities cannot go bankrupt like companies can. By having a portion of your portfolio in commodities rather than entirely in stocks and bonds, you can hedge against severe declines in the stock market.
A commodity portfolio may help you combat inflation without suffering the same losses as in a portfolio consisting solely of stocks and bonds. Commodities have performed well during past inflationary periods, even when stocks and bonds lost value.
Risks of Adding Commodities
Commodities tend to be more volatile than other options because their prices are driven by supply and demand. This volatility may mean that when you lose money, you lose a lot.
A traditional mutual fund might hold securities covering a wide range of industries. However, a commodity fund might have less diverse securities that give you exposure to only some industries.
There is no promise that an investment will perform well just because a commodity is in demand. Opening a commodity account and trading futures yourself should not be part of a strategy for building a retirement portfolio that you depend on for future income.
Commodity Investment Options
You may consider some types of investments to gain exposure to commodities in your portfolio.
Managed Futures
Managed futures allow you to trade in the futures market through a money manager. This may be one of the best ways to invest in the commodities market. Your money is often placed in a separate account managed by professionals who invest in a variety of commodities that can provide good returns over the years. They are not correlated with other investments like the stock market. This provides a solid degree of diversification.
Often
Managers of commodity futures funds are directed based on a trend-following approach. This is a good way to capitalize on large movements in commodity prices, whether they are upward or downward. Some investors diversify even within futures funds in their managed accounts. It might make sense to invest in a trend-following fund and a fund that trades within commodity ranges.
Commodity Exchange-Traded Funds
You can also invest through commodity exchange-traded funds (ETFs). There are a variety of commodity ETFs that invest in diverse commodities or in the companies that deal with them. Some invest only in a single commodity, while others invest in a specific commodity sector.
You can tailor your investment to what makes the most sense for you. It’s best to try to achieve broad diversification when choosing these funds for the long term. Commodity stocks have been one of the most popular options over the years. Gold mining stocks are among the favorites.
Conclusion
Commodities can help you diversify your long-term portfolio. They may enhance your returns if you understand the difference between speculation and investment. You should be aware of the rewards and risks involved.
Opening a commodity trading account without a plan should be considered speculation. Only risk capital should be used. Investors seeking long-term growth should allocate a portion of their portfolios to commodities that will remain relevant for decades to come. Investing money in commodities through managed commodity accounts provides an opportunity for exposure with lower risk than trading commodities on your own.
Note: The Balance does not provide investment services or advice. This information does not take into account the investment goals, risk tolerance, or financial circumstances of any investor. It may not be suitable for all investors. Investing involves risks, including loss of principal.
Source: https://www.thebalancemoney.com/how-much-commodities-investment-809211
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