Copper, Coffee, Gold, Oil, Wheat. These precious metals and agricultural products are all commodities. They’re the building blocks of the world and are essential to world progress and prosperity.
Commodity Definition: Typically used as the input of another type of good or service, commodities are basic goods which are traded across various markets. The quality of a commodity is generally uniform across producers so therefore consumer products such as televisions are not considered commodities since the products vary so much between manufacturers.
Are commodities a good investment choice for individuals?
The decision to invest or not in commodities is tricky. There are a variety of factors that affect commodity prices such as seasonality and cyclical patterns, and as a general rule of thumb commodities are considered one of the most risky types of investment. Commodity performance is very rocky so investing in them can be a bit of a gamble but, as with any risky bet, they can provide their benefits, too.
Unlike investing in an individual company commodities don’t provide any sort of dividend, and by themselves do not create their own value. One bar of gold is never magically going to turn into two bars of gold. Instead, in the world of commodities you are making a bet on supply and demand. The hope is that someone in the future will pay a higher price than what you can pay for a commodity now. In this asset class, timing is key.
Some schools of thought think that commodities can lower portfolio risk since the returns aren’t correlated with stocks, which may make them a good tool for diversifying your portfolio. Commodities are frequently discussed when market times are tough since commodities can be a safe haven when the economy is volatile. For example, many individuals still turn to gold, like the iBillionaire Gold Strategy, in times of crisis since it maintains its intrinsic value.
Commodities can also provide an interesting hedge against inflation. The price of commodities usually rise when inflation is accelerating, providing protection for your finances. Few assets benefit from rising inflation but commodities usually do. (1)
So is it worth adding commodities to your portfolio? Analysts such as Greg McBride at Bankrate.com suggest that commodities are important as part of a well-diversified portfolio, but only if you have a big enough pot saved away. Depending on your investment goals, a small allocation could be reasonable, particularly with an index ETF. But beware: concentration in a commodity allocation can easily destroy the diversification benefits of this asset class!
Commodities are certainly tempting and seem straightforward to a new investor. But many advocate that you should nail down the basics of investing first, before diving into the commodities world. Once you have your basic mixture of stocks, bonds and cash down, commodities could be an interesting alternative investment to look into, especially as part of a larger, long-term investing plan.
Whether or not to add commodities to your portfolio is an interesting debate and is one that will continue for many years to come. Before reaching your decision, make sure you do your research!