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Investing with Exchange-Traded Funds Made Easy: Higher Returns with Lower Costs - Do It Yourself Strategies Without Paying Fund Managers

Understanding Exchange-Traded Funds

Getting Started in Exchange Traded Funds (ETFs)

Previous:
Real Estate (REIT) ETFs

Next:
How to Build a Balanced Investment Portfolio with ETFs

Commodities ETFs

Commodities are physical, tangible things for which an active investing market exists. The most popular commodities are oil; agricultural products such as coffee, cattle, and wheat; and metals such as gold, silver, nickel, and uranium. Until recently, individual investors could own most commodities only by buying the actual commodity (gold bars, for instance) or futures contracts, complex investments typically reserved only for sophisticated or very wealthy investors. In the past few years, several ETFs have arisen that make it possible for anyone to buy a stake in certain commodities—particularly gold, silver, and oil.

Why Investors Buy Commodities ETFs

Most commodities have a very low correlation with the main stock-market indexes, even lower than that of REITs. For instance, the price of gold typically skyrockets when stock markets plunge. Similarly, the rise in the price of oil very often accompanies or foreshadows a fall in stock prices. Due to the low correlation between commodities and stocks, investors usually buy commodities ETFs as a way to hedge the overall stock market. In investing, hedging refers to the practice of buying two investments whose returns tend to have a low correlation, in an effort to reduce risk.

Why You Should Probably Avoid Commodities ETFs

High risk: Commodities are extremely volatile and therefore very risky.
Returns: Over the long term, stocks have tended to outperform commodities significantly. For instance, the price of gold tends to rise at a rate roughly equal to inflation, keeping its return after inflation close to zero.
Taxes: Currently, the IRS considers commodities (including most commodities ETFs) to be collectibles, like stamps or coins, which are taxed at rates roughly double those of long-term capital gains. If you’re determined to own commodities ETFs, it’s usually best to hold them in a tax-sheltered retirement account.

Popular Commodities ETFs

Currently, there are only a few commodities ETFs, but many more are in development. Single-commodity ETFs track the performance of just one commodity, such as oil. Commodity index ETFs track the performance of a diverse group of commodities.