If you take all of the gold in the world and put it into a cube, it will be a cube that’s about 67 feet on a side and 170,000 metric tons. You could get a ladder and get up on top of it and think you’re king of the world. You could fondle it, polish it … you could do all these things with it … but it doesn’t do anything. You’re hoping someone else in a year or five years will pay you for the thing.
When you buy a stock or a bond, its price in the marketplace reveals whether you’re likely to get a good return. With a commodity, you’re hoping to get one. That’s not good enough for me. My main point: Trying to get rich off commodities is a risky business indeed. Commodities can crater as quickly as they soar.
Although I don’t back them as an investment, they do tend to rise in inflationary environments so some financial experts advocate using them as an inflation hedge. For a financial expert, a hedge is a position taken to limit losses in a larger position. So an inflation hedge aims to preserve value when rising costs erode the purchasing power of each dollar.
Simply put, if your retirement portfolio is worth $500,000 and returns 5% per year, your purchasing power falls if inflation moves above 5%. Low-returning investments like cash and bonds therefore are hard hit. Stocks can lag a bit because companies’ costs for raw materials–metal, grains, petroleum–rise before they can increase prices. Meanwhile, of course, if you own those raw materials–commodities–they do well even as they hurt the rest of your portfolio. Taken all together, if inflation mounts, a small commodity position’s gains can help offset poor performance in bonds and even stocks.
Now inflation hedging is far from necessary for most people, but if you fear we’re verging on high inflation, here’s how to do it smartly. First, limit your investment to a single-digit percentage of your net worth. Second, use a broadly diversified portfolio designed to hold up well versus broadly rising prices–don’t simply “bet†on oil or gold. The experts at Morningstar consider Harbor Commodity Real Return Strategy Fund (HACMX), run by PIMCO’s Mihir Worah, to be the best such portfolio. Finally, rebalance from time to time to make sure your allocation doesn’t drift too low or become a larger portion of your portfolio.
Mellody Hobson is president of Ariel Investments L.L.C., a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds. She is also a regular contributor to ABC’s Good Morning America.