How Much of Your Portfolio Should be Invested in Commodities?

Ways to Invest in Commodities and Their Risks

Businessman with his wallet open.
Businessman with his wallet open. Roy Hsu/ Photographer's Choice RF/ Getty Images

Commodities have become more of a mainstream investment since the turn of the century and it can make sense to allocate more of an investment portfolio into them. Commodities don’t pay dividends, but they also don’t go bankrupt. They can help to diversify an overall investment portfolio, but the allocation really depends on how you plan on investing in them. 

Most investors feel that you have to open a commodities account and trade futures contracts if you want to invest in commodities, and that was the traditional path until a wide range of different investments came on the market.

The first thing to consider is what really constitutes an investment in commodities. There's a big difference between investing in commodities and speculating in them. Opening a commodities account and trading futures contracts with no trading experience is not exactly investing. It's more like speculation and that is risk capital. It's not part of an investment retirement portfolio.

Managed Futures

Managed futures are probably one of the best ways to invest in the commodity market. They're managed by professionals who typically invest in a diversified number of commodities and earn a decent return over a period of years. They're typically not correlated with other investments like the stock market, and this offers a strong degree of diversification to an investment portfolio.

Managed futures fund managers are often guided by a trend-following investment approach. This is an excellent way to catch large movements in commodity prices, whether they're up or down.

Some investors even diversify within different managed futures funds. It can make sense to invest in a trend-following fund and a fund that trades the ranges in commodities.

Commodity ETFs

One of the purest ways to invest in commodities is through commodity ETFs. There are a wide variety of funds that invest in a diversified group.

 Some only invest in a single commodity and others invest in a particular commodity sector. You can tailor your investment to whatever commodities make sense for you. It's best to try for a widely diversified group when you're choosing commodity ETFs for a long-term investment.

One of the more popular commodity investments over the years has been commodity stocks. Gold-mining stocks are among the favorite investments in the commodities arena, but it has become more popular to invest in other mining, oil drilling and other natural resource stocks. Many agriculture stocks have become household names, such as grain prices that have been setting record highs.

For the Long Term

A wide variety of different investments in commodities can help diversify a long-term investment portfolio and will likely increase your returns if you recognize the difference between speculation and investments.

If an investor wants to allocate 5 to 15 percent of his investment portfolio in commodities, it should be in long-term investments that will still be around in 20 to 30 years. Opening a commodity trading account with no trading experience or plan is not investing unless you eventually learn how to trade properly and can consistently make money.

It often takes a significant amount of time, money and effort to do that. Until that status is achieved, trading should be considered speculation and only risk capital should be used.

Commodities typically move in long-term cycles of 10 to 18 years. A buy-and-hold approach typically works very well when they're in a long-term bull market.