Oil, gold, energy, and crops are all included in a type of investment that's known as commodities. Adding commodities to your portfolio creates exposure to more than one resource. It helps to reduce risk and to diversify your investing strategy. It hedges against inflation.
But loading the back of your truck with bags of wheat, barley, and hops is the wrong way to buy commodities unless you’re planning to open your own microbrewery. Commodity exchange-traded funds (ETFs) provide an option to invest.
- ETFs let you invest without taking physical possession of the resources.
- ETFs are designed around every commodity on the market. There's no shortage of choices.
- Commodities are volatile, but ETFs tend to reduce much of that risk.
What Are Commodity ETFs?
Commodity ETFs are a simple way to include resources in your investment goals. You'll benefit by gaining exposure to their price and performance without owning the resource itself. These ETFs consist of stocks or futures and derivative contracts that track the prices of the resource. ETFs also track indexes in some cases.
One of the more popular commodity ETFs is the iShares S&P GSCI Commodity-Indexed Trust (GSG). You'll own futures contracts for livestock, industrial metals, and agricultural assets. You'll gain exposure to various commodities as a result. But you won’t have stacks of metal and herds of cattle in your backyard.
Types of Commodity ETFs
You can find commodity ETFs to fit just about any of your goals. There are broad-based funds that track many types of commodities, such as the iShares GSG. Some track just one commodity like oil, gold, or energy. You can find sub-sectors like solar energy ETFs that track only one type of energy.
Should You Buy Commodity ETFs?
One advantage of these ETFs is that they simplify trading. Without an ETF, you would have to make individual purchases of commodity futures or invest in related derivatives or companies. You can invest in your chosen commodities without purchasing a contract or getting involved in trading.
You'll have instant exposure to the price and performance of a particular commodity in one trade.
You have to decide which futures or companies to choose. There's still the challenge of purchasing all the equities in the index basket to target a certain price if you decide to invest in an index. Paying commissions can make it hard to achieve your goals.
But you make one trade at one price and save on commissions in the case of an ETF. It's already bundled ahead of time.
Advantages of Buying Commodity ETFs
Capital gains taxes aren’t incurred until the sale of an ETF. This gives them a tax advantage over other products, such as mutual funds. You'll also have a simpler trade. You'll have lower commissions and management fees.
How to Invest and Trade
Make sure to conduct plenty of research before you trade any commodity ETF. Track the performance of the price of certain resources, like coal. Watch how some of the major ETFs react to market conditions.
There's a lot of criticism about commodity ETFs that consist of futures contracts because they have a hard time tracking volatile commodities. But you can get started by using these ETFs and ETNs in your investing arsenal when you have a good understanding of how commodities and commodity ETFs interact.
There's still inflation and market risk with commodity ETFs. But they give you diversity to help hedge these risks. You do have management and trading risk with any ETF.
Some strategies can help you make your first investments in commodity ETFs. You can sell a gold ETF with one trade. This helps reduce your downside gold risk if you're looking to stabilize some gold investments in your portfolio.
You can use an energy ETF to hedge the downside risk for both industry and foreign investments. Sell an energy ETF to hedge your downside risk if you're long on a lot of energy stocks.
Foreign investments in a country where coal is a major source of income would provide a chance to sell a coal ETF to protect the downside.
Trading ETF options can be a good plan if you don’t want to close your ETF positions but want short-term exposure or protection.