Advantages And Risks Of Investing In Commodities – What You Need To Know

advantages vs risks investing in commodities

Commodities such as metals, crops, and oil make popular investments, and a well-managed portfolio can reap lucrative rewards. However, as with all investments, commodities carry risks, with the possibility of losing more capital than you make. But by being aware of the common pitfalls, you can take steps to minimize the risks of commodity investment and boost the opportunities for reward. 

What Are Commodities? 

Investing in commodities means investing in a physical asset, and there are many different commodities from which to choose. There are three main categories: Hard commodities, which are mined, including precious and industrial metals; soft commodities, which are grown; typical examples being wheat, rice, coffee, and sugar; and energy commodities, including oil and natural gas. 

When deciding whether to invest in commodities, many investors choose to invest in both shares and commodities, resulting in a diverse portfolio. Others choose to specialize in commodities. An excellent example of this is female industrialist, Malini Saba who, since founding Saba Industries Group in 1992, has established a reputation as a leader in her field with a successful track record in the industrial commodities market. 

Advantages Of Investing In Commodities 

There are several reasons why investing in commodities can yield good returns. These include: 

• Diversification 

For those already investing in stocks, diversifying by also investing in commodities can help reduce the risks. Typically, commodities do the opposite of stocks, rising when stocks are falling. By balancing a portfolio with stocks and commodities, the chances of an overall loss decrease. 

• Opportunities For Rapid Growth 

Usually, investments have slow or steady growth rates, but the price of commodities can rise very quickly. Commodity prices react to global demand and if demand increases rapidly, so does the value of the commodity. A good example of this is the price of iron ore in 2008-10. Economic growth in China caused a surge in demand for iron ore, resulting in rapidly rising prices. 

• Inflation Protection 

Inflation affects all sectors of the economy, and for those investing in stocks, it can impact stock prices and returns for investors. However, as inflation typically increases the cost of goods and services, the commodity price also rises. Investing in commodities can, therefore, help protect a portfolio from the negative impact of inflation. 

Risks Of Investing In Commodities 

While there are good opportunities to make significant gains when investing in commodities, there are also risks that can hit even seasoned investors. These include: 

• Volatility 

Commodities are considered one of the most volatile assets, considerably more so than stocks and bonds. They cover a vast range of assets, with some more stable than others, which is worth bearing in mind when choosing commodities for investment. However, with commodities easily affected by geopolitical events, changes in prices may be difficult to predict; wars, natural disasters, or supply chain issues can all hit prices. Of course, volatility is not always a bad thing – it can send the value of your assets soaring, but it does also add a significant risk of losses. 

• They Do Not Generate Income 

There are no dividends paid on commodities, and there is no interest. Profits are made solely on the price appreciation of the asset, and if the commodity’s value depreciates, capital can be lost by an investor. 

• A Long-Term Investment 

The best chance of making gains from commodities is to consider them a long-term investment, keeping them throughout the rises and falls that such a volatile market brings. For those wanting a long-term investment, this is not a bad thing, but it does mean that capital is kept unavailable for other investments and, if it is withdrawn at the wrong time, may result in a loss. 

Do Your Research 

Commodities investing is not an easy market to negotiate. Instead, time spent thoroughly researching how the market works is time essentially spent. With commodities covering such a wide variety of assets, it is also worth looking into the risks and advantages for individual commodities. Similarly, if you use a broker for your commodities investments, make sure it is one with experience and a successful track record in commodity trading. The market is well regulated, and a good broker will be happy to demonstrate their expertise and answer any questions you may have. 

Commodities Conclusion

As all investors should know, when investing, income can go down as well as up and past performance is not necessarily a guide for future performance. Commodities investment is no different and has risks unique from other investments. Speak to an investment professional before investing significant amounts into commodities and don't invest more than you can afford to lose. But overall, if you have done sufficient research into commodities trading, investment in commodities can help diversify your portfolio and allow you to take advantages that other forms of investment cannot give you.

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