Commodities Never Belonged in Your Portfolio

Earlier this year, strategists and investors came out in droves to embrace commodities to weather surging inflation. This looked like a brilliant move at first as oil, metals and grains all rallied, but investors who held on to those positions are seeing their winnings largely eviscerated by a brutal snapback. In reality, most individual investors had no business investing in commodities in the first place.

Commodities can make for great trades, but they are often lousy investments. Unless you happen to own your own warehouse, you assume a cost to store them, which means it’s hard to make any money holding them for the long term. If investors get in at a peak chasing fad portfolio construction techniques, the returns can be much worse.

The Bloomberg Commodities Index is a good illustration. On a spot basis, it is up 351% in the past two decades, a respectable 7.8% compound annual growth rate that’s just slightly behind the S&P 500 Index’s 9.3%. But that’s not what investors earn when they invest through financial instruments because it doesn’t account for the cost of rolling such futures contracts. Among other things, there’s a sizable cost associated with storing barrels of crude oil, tanks of natural gas and bushels of wheat. In part because of these additional costs, the total return version of the same index — based on financial instruments that track the commodities — is up only 50% in the same period (a meager 2% compound annual growth rate).