Commodity Funds: Risks & True Portfolio Diversification

Many investors turn to commodity funds as a way to diversify their portfolios. However, this illusion of diversity can sometimes lead to trouble. Here are a few things to consider about commodity funds and how they might affect you as an investor.

Commodity Fund Risks

The point of diversification is to reduce your overall risk in your portfolio. However, by investing in commodity funds, you may actually be increasing your degree of risk. Since commodities are a tangible asset, they are subject to their own types of risks. For example, many people invest in agricultural crops as part of a commodity fund. If the crops are subject to harsh weather, an entire harvest could be lost. A bad season could affect many crops in a given commodity fund and drastically lower your returns. This could devastate the value of your investment and, by extension, your portfolio.

Lack of Diversity

A commodity fund might prove to be not as diverse as you would like as an investor. Many commodity funds will invest in similar commodities that are highly correlated. For example, a precious metals fund might invest heavily in gold and silver. The prices of these commodities tend to move in sync with one another. Therefore, this could result in significant losses for your portfolio when the prices go down.