How to Invest in a Commodity Index
Exchange-traded funds (ETFs) and exchange-traded notes (ETNs) have made commodity investing accessible to individual investors. Commodities investing offers diversification, low correlation to other investments such as stocks, and an inflation hedge. Here's how individual investors can easily invest in a commodity index.
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Instructions
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Familiarize yourself with the most popular commodity indexes. Just as different stock indexes offer different avenues for stock index investors (for example, the Dow versus the S&P 500), there are a number of different commodity indexes available for commodity index investors. Each index differs in composition and in the weighting of the commodities which comprise the index. Some of the most popular commodity indexes include: The S&P/GSCI Index, the CRB Commodity Index, the Deutsche Bank Commodity Index, and the Rogers International Commodity Index. The components forming each of these indexes are all publicly available and easily accessible on the internet (see links at the end of the article).
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Decide which index best fits your individual investing strategy. For example, the Rogers index has less weight in energy versus many of the other commodity indexes, but generally covers a greater number of different commodities overall. Conversely, the DB Index currently has over half weight to crude oil and heating oil. If you already own a lot of stocks in oil companies, agriculture companies, or mining companies, you want to consider this when allocating your investment into the commodities themselves.
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Research the ETF and ETN products that track the commodity indexes. If you don't know where to start, try Googling the commodity index names listed above with the terms "ETF" and/or "ETN". This search will easily turn up some ticker symbols referenced by investment-related websites. Then, when you find the name of a potential ETF, Google the name of the ETF to find the issuing company's website. On the issuer's website you will be able to find a prospectus and information such as the expense ratio for the ETF. There you will also be able to learn more about the mechanism by which the ETF attempts to track its underlying commodity index.
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Tips & Warnings
Like any investment, commodity ETFs have their own risks. For example, there are a number of reasons why commodity ETFs may not exact track the underlying index that they attempt to replicate. This may be because the ETF invests in futures contracts, and the process of "rolling" futures contracts can create tracking error. Tracking error means that your investment may not perform exactly as the index performs.
Commodity ETFs and ETNs often have different tax consequences than stocks or stock ETFs. Consult with a financial planner or your tax advisor to understand these differences and to make sure that you choose the right product in light of your tax situation. This can get complicated, and is beyond the scope of this particular article.
Commodity ETNs (and even some commodity ETFs) may have what is commonly called "issuer risk". That is, the ETF or ETN may wholly or partially be composed of debt instruments underwritten by a financial institution. If the underwriting financial institution fails, you may lose some or all of your investment, even if the underyling commodity index does as you expect it to. In other words, unlike a stock, which represents ownership in a company, a commodity ETF is composed of other financial instruments which have their own risks. The prospectus is required to outline the nature of those instruments.
