I’ve written many articles about commodities and the opportunities for investment in them on Financial Expert. I sometimes even mention the asset class of commodities when writing articles aimed at beginners. But are commodities mutual funds, ETFs, futures contracts and commodity physical holdings suitable for new investors? Are commodities suitable for a beginner who only has 6 months of investment experience?
The straight answer is no, in very few circumstances is it recommended for a beginner to invest in commodities. And here are the reasons why:
Commodities May Not Be Suitable For Beginners or New Investors Because:
1. You’re probably investing based on tips/advice/positive media coverage/historical performance/regret.
These are all very influential when a new investor decides how to construct their portfolio. If you feel like a bit of a beginner, and experts are shouting about how amazing the list of precious metals ETFs are doing right now, it is difficult, nay impossible for a new investor to not feel a little more comfortable in picking gold as part of their portfolio. It’s part of human nature to go along with the crowd and it makes us feel safe. This is why new investors are so vulnerable – because they feel unsafe.
I would prefer if you reacted in the opposite way to such stimuli. I would rather you looked at a graph of smooth and high returns and start worrying. I would prefer it if excessive media coverage put you off from investing in a particular type of asset. If this was your reaction, you wouldn’t have been in tech stocks in the dot com boom.
2. Your portfolio probably isn’t large enough to ‘handle’ commodities
Commodities are volatile instruments and the general consensus appears to be that 5% a sensible maximum asset allocation. If you gain this exposure through one ETF which covers a basket of commodities, you will want to invest at least £1,500 to push commission (and relevant taxes) down to below 1% of your initial purchase. With such a ratio, and the requirement that commodities staybelow 5% of your total assets, you would need a portfolio of £30,000. This is hardly where most investors start at. And this is assuming that you only invest in one fund. If you decided to create a ‘DIY’ commodity position using industrial metals like Copper ETFs, resources like this list of Oil ETFs as well as precious metals such as Palladium ETFs then this would increase your total portfolio requirement even further.
The rule is to not include exotic and alternative investments in a portfolio until your assets are large enough such that you can make efficient trades with 3%-5% of your portfolio. By efficient I mean that trading costs are not above 1% of your investment.
3. You may not be including commodities for the right reasons.
Are you including commodities because you firmly believe that in the medium to long term they will produce returns at least on par with equities? If so, I would ask you to reevaluate your investment strategy and understanding of the asset classes. While commodities have produced good returns this decade, there have been periods of 20 years or so where certain commodities have ended lower than they began. Unlike stocks, which represent growing organisations that have the ability to innovate, commodities represent a static object that relies on supply shortages for value, and is vulnerable to improvements in technology and changes in demand. Commodities real value is that they overally have positive expected returns, and at the same time, move with negative correlation to stocks, which is the ‘dream’ of anyone who wants a diversified portfolio.
Each is to their own, as they say. However make no mistake: I recommend that commodities are included within a portfolio to aid the simple science of diversification, not because I think they will actually out-perform stocks.
4. You may not understand the costs, fees and drawbacks of holding commodities.
Commodities investments are the most complicated and hindered investments you can make. You have commodity ETFs that have failed to replicate the spot price. You have spread bets that come with not just financing, but costly holding charges applied on a daily basis. You may decide that the best way to hold gold is to buy gold bullion coins, which will require good knowledge, suitable storage and of course, insurance. Alternatively you could invest in commodity explorers and miners, however their prices will be affected by risks other than the price of commodities. As you can see, there really is no perfect way to invest in commodities. It is merely a case of investing in the least costly and most appropriate option. Therefore I wouldn’t say commodities are suitable for beginners or new investors, until they fully understood all the routes involved.
To help discover which option is best for you, read our basic guide on How to Invest in Commodities.