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Finding a Fit for Commodities in your Portfolio

These days, advertisements for investing in commodities are nearly everywhere. On television, radio and billboards, famous and not-so-famous people champion products like gold, silver and oil as good, reliable investments.

The appeal is easy to understand; at a time when many investors are still licking their wounds from losses suffered during the Great Recession, can’t we all sympathize with the urge to invest in something that retained its value during the crisis?

But is there really room in your portfolio to invest in commodities? What are the drawbacks? Are there risks involved?

You should understand the characteristics of commodity investments and determine an appropriate level to include in your overall asset mix before making any investment decisions. Generally speaking, commodities should not be considered a substitute for your core investments in stocks, bonds and cash-equivalent instruments.

The complexities of commodities

Gold and oil are the two most visible commodities considered for investment purposes. But a wide range of commodities ranging from natural gas and copper to pork bellies fall into this category. Finding investment success in any single type of commodity can be challenging, particularly for those with little experience in this market. Commodity prices have a history of significant volatility. Prices can change dramatically and with little notice. That is a recipe for potential investment disaster if you are not careful about choosing the right investment. Consider the volatile nature of prices on oil futures contracts on the New York Mercantile Exchange in recent years. Based on data published by the Wall Street Journal in July 2007, oil was up to $78 per barrel. About one year later, oil futures topped the $145-per-barrel mark. By December 2008 – five months later – the price of an oil future contract fell to just $35 per barrel. This type of price movement is an indication of the risks associated with investing in a single type of commodity.

Yet if structured correctly within a diversified portfolio, commodities can help reduce volatility in your overall investment mix. Often, commodity prices tend to move in a different direction from the stock and bond markets.

In the period from October 2007 to March 2009, the stock market, as measured by the Standard & Poor’s 500 stock index (an unmanaged index of stocks), lost 57 percent of its value. During that same period of time, gold prices (based on the spot price of gold on the Commodity Exchange, or COMEX) rose 25 percent, which helped smooth the performance of a portfolio that included gold in the mix.

Using a cautious approach

While investing in any single type of commodity may carry undesirable risk for most investors, good cases can be made for other approaches that are readily accessible.

Commodity-focused mutual funds or exchange-traded funds (ETFs) are two alternatives to consider. Funds like these offer diversification within the marketplace to provide a degree of protection from the volatile nature of individual commodities markets. Some funds invest specifically in commodity-related indexes. Others may invest in companies that participate in selected commodity businesses, such as oil exploration firms or gold mining companies.

It makes sense to talk to your investment advisor and try to determine the most appropriate way to diversify into commodities within your overall portfolio.

Brokerage, investment and financial advisory services are made available through Ameriprise Financial Services, Inc. Member FINRA and SIPC. Some products and services may not be available in all jurisdictions or to all clients.

This information is being provided only as a general source of information and is not intended to be used as a primary basis for investment decisions, nor should it be construed as advice designed to meet the particular needs of an individual investor.

Commodities investing involves substantial risk of loss, including volatility risks associated with investing in a narrowly focused sector, and may not be suitable for all investors. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Past performance does not guarantee future results.

Diversification helps you spread risk throughout your portfolio, so investments that do poorly may be balanced by others that do relatively better. Diversification does not assure a profit and does not protect against loss in declining markets.

The Standard & Poor’s 500 Index (S&P 500 Index), an unmanaged index of common stocks, is frequently used as a general measure of market performance. The index reflects reinvestment of all distributions and changes in market prices, but excludes brokerage commissions or other fees. It is not possible to invest directly in an index.

Investment products, including shares of mutual funds, are not federally or FDIC-insured, are not deposits or obligations of or guaranteed by any financial institution and involve investment risks, including possible loss of principal and fluctuation in value. ETFs trade like stocks, are subject to investment risk and will fluctuate in market value.