What Is a Commodity Fund?
Investing in commodities can potentially be very rewarding, but the process is confusing, and can result in disastrous losses if not done properly. Commodity funds offer a way to become involved with the commodity market while minimizing risks and potentially offering great returns. If properly understood, commodity funds can be a valuable addition to your investment portfolio.
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The Facts
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Commodities are goods that are interchangeable, regardless of the source. For example, a bar of gold is basically the same no matter who produces it. The price of a commodity is the same everywhere, and changes according to supply and demand. This is different from automobiles, for example, where quality and price can vary widely between manufacturers. Some commodities include agricultural products, precious metals, livestock and natural resources.
Function
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Commodity funds are mutual funds that allow investors to participate in commodities trading while minimizing risks. True commodity funds actually hold the commodities in which they invest, such as gold or soybeans. More commonly, funds hold futures, or contracts that they sell before the commodities are delivered. These funds hope to profit from price changes in the value of a particular commodity, rather than own the commodity itself. The prices of futures contracts are determined by supply and demand, rather than the actual value of the commodity itself.
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Features
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Commodity funds allow investors to own a variety of commodities, or a number of companies producing a commodity, with one purchase. For instance, you could invest in a fund that represents various commodities in proportion to how much is produced around the world. If you have an interest in a particular commodity, there is likely a fund investing in various companies producing that commodity. This allows you to reduce the risk of investing in one specific company.
Benefits
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You can use commodity funds to help diversify your investment portfolio. If you are interested in investing in commodities but don't wish to physically buy wheat, cattle or silver, a commodity fund can allow you to invest in all of these and more without actually owning anything. Commodities also provide a hedge against inflation. Prices of commodities tend to rise during inflationary periods, since the goods are more expensive, as opposed to stocks, which generally lose value when inflation rises.
Considerations
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The commodities market can be very volatile. Prices can fluctuate wildly in a short period of time, or remain stagnant for months. Commodity funds can return great rewards, but if your tolerance for risk is low, you may not be comfortable holding them in your portfolio. Be sure that your investment in commodity funds fits in with your overall investment strategy. If the price of gold is high, you may be tempted to add gold funds, but don't forget to consider the effect on your portfolio if the price of gold drops.
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