How Does a Commodity Mutual Fund Work?
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What is a Commodity?
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A commodity mutual funds works like any other mutual fund. The money of investors (or shareholders) is pooled into a fund that is managed by a professionally trained investment adviser. But instead of buying and selling stocks and bonds, the fund buys and sells commodities. Commodities are naturally occurring or grown products. These include oranges, wheat, livestock, coffee, lumber, gold, sugar, crude oil, pork bellies, cotton, and numerous other items that are a part of our daily lives.
How Commodities Work - The Simple Version
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Items like lumber, wheat and cattle are all part of the national and, in some cases, international marketplace. These commodities are a part of many industries such as food growers, oil and builders and the prices reflect supply and demand. For example, if the orange orchards in Florida have a severe frost, then the price of orange juice will increase because fewer oranges are available. Many companies buy the products they need on the commodity exchanges, or marketplaces where items are bought and sold. Companies enter into contracts to buy a commodity at a certain price for a specific delivery or expiration date. Usually, when the contract expires, a company takes delivery of the commodity. But investors can make money by accurately predicting whether the price of a commodity will go up or down in value. Their contracts are called futures for future delivery, although few investors ever take delivery. Near the expiration date, the investor gets out of the contract before delivery. But investing in commodities is one of the most sophisticated investments around and is only for truly experienced people. If you want to make money from items you use on a daily basis, the best way is to invest in a commodity mutual fund.
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Why Invest in Commoditiy Mutual Funds?
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Commodity mutual funds are a good way to get started with commodity trading. It is much easier and safer to invest in a mutual fund than to start trading commodities on the exchanges. The fund manager makes all the buying and selling decisions for the fund to maximize the ROI, or the return on investment. One of the best things about a mutual fund is the diversification. With a commodity mutual fund, the manager has many different types of commodities to choose from to create the portfolio. Diversification reduces risk and volatility, which in turn can keep your investment safer. While huge fortunes can be made (and lost) in one day when trading a commodity, having many commodities in a fund averages the extreme lows and highs that are possible.
How to Invest
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There are not as many commodity mutual funds as there are stock and bond mutual funds, but there are lists of top-performing funds. Read Business Week and Futures magazines to find mutual funds that perform well. The PIMCO Commodity Real Return Strategy Fund is popular, as is the Oppenheimer Real Asset Fund. As with any mutual fund you need to read the prospectus and all other relevant material provided by the fund. Read a book or two on commodities to really understand what it is the fund manger is doing. Since you will be investing your money, it is important to know what investing in commodities entails. Commodity mutual funds are a complicated investment, but it is also a good way to make money.
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