Commodities are the raw materials or basic goods that are used to produce many of the things you use every day. Investing in commodities such as crude oil, soybeans, livestock, and wheat can be an effective way to diversify a portfolio, hedge against inflation, and potentially generate returns.
Why Invest in Commodities?
Commodities are alternative investments that offer a low correlation to traditional asset classes like stocks or bonds. Thus, holding commodities in your portfolio can help minimize the impact of market volatility, as commodities prices are driven largely by supply and demand rather than the mood of the market.
Investing in commodities can also be a strategic play for investors who are hoping to counter the effects of rising inflation. As prices for consumer goods rise, the prices of the underlying commodities used to produce them also tend to rise. Stock prices, by comparison, do not always move in tandem with inflation.
Commodities can also be highly liquid assets, depending on how you’re trading them. Liquidity may be of importance to investors who are focused on generating short-term returns, versus a longer-term buy-and-hold approach.
💡 Quick Tip: While investing directly in alternative assets often requires high minimum amounts, investing in alts assets through a mutual fund or ETF generally involves a low minimum requirement, making them accessible to retail investors.
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5 Ways to Invest in Commodities
If you’re considering investing in commodities, there are several options to choose from. The one that makes the most sense for you will depend on your risk tolerance, time frame for investing, and how much capital you have to invest.
1. Physical/Direct Ownership
Physical ownership of commodities may be impractical for most individual investors as it involves taking ownership of the actual commodity. Purchasing and storing two tons of wheat, or maintaining 1,000 live animals likely isn’t realistic if you don’t have the proper facilities.
On the easier end of the spectrum, precious metal investors may hold gold or silver as bullion, or coins inside a secure bank vault. But even then, holding quantities of specific metals also require storage, insurance; and reselling these commodities comes with liquidity issues.
2. Commodity Mutual Funds and Exchange-Traded Funds (ETFs)
Commodity mutual funds and exchange-traded funds can offer exposure to commodities without requiring you to hold anything physically. There are three broad categories of commodity funds you might invest in:
• Physically backed funds. These funds maintain direct ownership of commodities, specifically, precious metals. A gold commodity ETF, for example, may hold gold bars at a bank.
• Futures-based funds. Futures-based commodity ETFs invest in futures contracts. We’ll explain those in more detail shortly, but in general, a future contract is an agreement to buy or sell an asset at a predetermined price on a set date.
• Commodity company funds. Commodity company funds invest in commodity producers. For example, you might buy shares in an oil ETF that invests in oil and gas companies, oilfield servicers, and pipeline companies.
The main difference between a commodity mutual fund and a commodity ETF is how they’re traded. Mutual fund prices are set at the end of the trading day, while ETFs trade on an exchange just like a stock. Both commodity mutual funds and ETFs charge expense ratios, which represent the cost of owning the fund on an annual basis.
3. Commodity Futures Contracts
Commodity futures contracts are an agreement to buy or sell an underlying asset at a future date. The contract includes the price at which commodities will be bought or sold. Futures are derivative investments, meaning their value is determined by the price of another asset, i.e., the commodities you’re agreeing to trade.
Trading commodity futures contracts can be risky, as outcomes rely largely on investors making correct assumptions about which commodity prices will move. It’s possible to lose money on futures contracts if you’re expecting prices to increase but they decline instead.
4. Individual Stocks
Investing in stocks of commodity companies is another way to gain exposure to this asset class. For example, if you’re interested in adding energy sector assets to your portfolio you might buy shares in companies that produce oil, natural gas, solar technology, and so on.
Purchasing individual stocks can ensure that you’re only owning the companies that you want to, unlike a commodity mutual fund or ETF, which can hold dozens of different investments. However, picking individual stocks can be a bit more time-consuming and it may take more capital to buy shares if you’re choosing high dollar stocks.
5. Hedge Funds
Hedge funds are private investments that pool money to buy and sell assets, similar to a mutual fund. The difference is that hedge funds tend to use high-risk strategies like short-selling and may require a higher minimum investment to buy in or limit access to accredited investors only. Under SEC rules, an accredited investor is someone who:
• Has $200,000 or more in annual income ($300,000 for married couples) for the previous two years and expects the same level of income going forward
• Has a net worth exceeding $1 million, not including their primary residence
Financial professionals who hold certain securities licenses also qualify for accredited status.
Hedge funds can potentially offer higher returns than other commodity investments, but the risks are greater as well. If you’re considering private investment in commodities through a hedge fund you may want to talk to a professional about the pros and cons.
💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.
How Do You Open a Commodities Investing Account?
Opening a commodities trading account is no different from opening any other type of brokerage account. You’ll first need to decide which brokerage you want to trade with, then complete the necessary paperwork and funding requirements to start trading.
Personal Information
When you open a brokerage account, you’ll need to provide some basic details about yourself. That includes your:
• Name
• Date of birth
• Social Security number
• Email and phone number
• Mailing address
• Driver’s license number
• Annual income
• Net worth
• Employment status
• Investment objectives and risk tolerance
You may also be asked about your experience with investing and your citizenship status. You’ll need to disclose whether you’re employed by a brokerage firm.
All of this information is required to verify your identity, meet FINRA’s suitability requirements, and comply with anti-money laundering regulations. Net worth and income information may also be used to determine whether you meet the standards for an accredited investor.
Minimum Funds
The minimum amount of money you’ll need to invest in commodities through your brokerage can depend on what you’re investing in. If you’re buying individual commodities stocks, then the stock’s share price will determine how much you’ll need based on the number of shares you plan to buy.
With commodity mutual funds minimums are typically determined by the brokerage. So you might need $1,000, $3,000, or $5,000 to get started, depending on what you’re buying. Commodity ETFs sell on a per-share basis, similar to stocks.
Some brokerages offer fractional share trading, which allows you to buy shares of mutual funds, ETFs, or stocks in increments. The minimum investment may be as low as $1, though it’s important to keep in mind that it can take time to build up the commodity portfolio of your portfolio when investing in such small amounts.
Trading futures can be a little trickier as you may need to meet a minimum investment requirement and margin requirements. Margin is a set amount of money you’re required to deposit with the brokerage as a condition of trading futures contracts.
Margin is typically calculated as a percentage of the contract but it can easily run into the thousands of dollars.
Pros and Cons of Investing in Commodities
Investing in commodities has advantages and disadvantages, and it may not be right for every investor. Examining the pros and cons can help you make a more informed decision about whether it’s something you should pursue.
Pros
• Commodities can help you diversify your portfolio beyond traditional stocks and bonds.
• Investing in commodities can act as an inflationary hedge since commodity prices usually move in sync with increases in consumer prices.
• Commodity ETFs and mutual funds offer a lower barrier to entry versus direct investment or hedge funds, making commodities more accessible to a wider range of investors.
• Returns may potentially outstrip stocks, bonds, and other investments.
• Commodity trading may generate short-term profits
Cons
• Commodity prices can be volatile, as they may be affected by natural disasters, geopolitical conditions, and other factors.
• Investing in commodities is generally riskier than other types of investments since supply and demand can impact trading.
• Holding physical ownership of commodities may not be feasible for every investor.
• Futures trading in commodities is highly speculative and while there may be potential for higher returns, there’s also more risk involved.
Is Investing in Commodities Right for Me?
Whether commodity trading makes sense for you can depend on your preferences concerning risk and your time horizon for investing. You might consider commodities if you are:
• Comfortable trading the potential for higher returns against higher risk
• Looking for short-term gains versus a long-term, buy-and-hold investment
• Savvy about futures contracts (if you plan to trade futures)
• Have sufficient capital to meet minimum investment requirements
Before investing in commodities, it’s helpful to learn more about the different types and their associated return profiles. It’s also wise to consider any costs you might pay to trade commodity ETFs, mutual funds, and stocks or the margin requirements for commodity futures trading.
The Takeaway
Although the commodities market is complex, commodities themselves are tangible products that are relatively easy to understand. Investing in commodities can take many forms, including direct or cash investment via the spot market, or by investing in commodity-related funds.
Although trading commodities comes with its own set of risks, commodities may offer some protection against inflation and traditional market movements, because these products are driven by supply and demand.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
Are there IRA accounts that specialize in commodity trading?
Some brokerages offer an IRA that’s designed for trading commodity futures contracts. You may also be able to gain exposure to commodity ETFs or mutual funds with a regular traditional or Roth IRA.
How much money do I need to invest in commodities?
The amount of money you’ll need to invest in commodities will depend on which vehicle you’re using. With a commodity stock or ETF, the amount of money required would depend on the share price and the number of shares you plan to purchase. Direct investment, hedge fund investments, or commodity futures contracts may require a larger financial commitment.
Can you make money with commodities?
Investors can make money with commodities through capital appreciation or by trading futures contracts. Returns may be higher than traditional assets but you may need to accept a greater degree of risk when trading commodities.
What is the risk profile for someone investing in commodities?
Investing in commodities often means being comfortable with more risk, as commodity prices can fluctuate quickly. You may want to limit your commodities allocation to 5%-10% of your portfolio to minimize your risk exposure.
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