How to Diversify a Commodities Portfolio

One way to reduce and manage risk with Commodities investments is to diversify risk across a broad spectrum of commodities. Diversification spreads out risk over a variety of investment ideas, so that no single idea can be fatal to your portfolio.

Instructions

1. A good way to diversify is to invest with a commodities fund, which invests in a broad basket of commodities for you. This is not unlike the concept of investing in a stock fund or several stock funds.

2. Allocate your own commodities portfolio. Use an index such as The Goldman Sachs Commodities Index (GSCI) as your basis. The index represents some 20 commodities in five sectors: energy, agriculture, livestock, industrial metals and precious metals.

3. Allocate no more than 10 percent of your available funds in any single commodity at a time. For instance, no more than 10 percent of your portfolio should be into gold futures or options.

4. Sell covered put and call options as part of your overall commodities portfolio diversification plan. This means that if you own 10 wheat futures contracts, sell up to 10 wheat put options to diversify your position. Besides protecting your futures position, the sale of put options generates income.

5. Diversify over time. For grains, different contract months represent "old crops" and "new crops" still to be harvested. Use "Spreads," which are based on supply and demand between old and new crops.