How Much of Your Portfolio Should be Invested in Commodities

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 makes sense to allocate more of an investment portfolio into commodities. Commodities don’t pay dividends, but they also don’t go bankrupt. Commodities help diversify an overall investment portfolio, but the allocation really depends on how you plan on investing in commodities.

There are many different ways for investors to invest in commodities.

Most investors feel you have to open a commodities account and trade futures contracts in order to invest in commodities. 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 is a big difference between investing in commodities and speculating in commodities.

Opening a commodities account and trading futures contracts with no trading experience is not exactly investing in commodities. It is speculation and that is risk capital. It is not part of an investment retirement portfolio.

Managed Futures

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

Managed futures fund managers often follow a trend following investment approach. This is an excellent way to catch large movements in commodity prices, whether it is 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 commodity funds that invest in a diversified group of commodities. Some of the funds only invest in a single commodity and others invest in a particular commodity sector. You can tailor your investment into whatever commodities make sense for you. It is best to try and have a widely diversified group of commodities when you are choosing commodity ETFs for a long term investment.

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

For the Long Term

As you can see, there is a wide variety of different investments in commodities that will help diversify a long-term investment portfolio and likely increase the returns. The main point of this article is that an investor needs to realize the difference between speculation and investments.

If an investor wants to allocate 5-15 percent of his or her investment portfolio in commodities, it should be in long-term investments that will be around in 20 to 30 years.

Opening a commodity trading account with no trading experience or plan is not investing. It is another story if someone eventually learns how to trade properly and they can consistently make money from trading commodities. However, it usually takes a large amount of time, money and effort to do so. 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. When they are in a long-term bull market, a buy and hold approach typically works very well. The price of gold moved from around $250 in 1999 to about $1,900 twelve years later. You really can’t beat those returns, even if you were actively trading.