Exchange-traded funds: Time to jump in?

By Money Matters Editors

Exchange-traded funds, which issue securities backed by the item invested in, have become a popular way for typical investors to play the commodities market. The question is, should you invest in an ETF?

In a word: no. Exchange-traded funds do give investors access to commodities, but the premise is flawed: typical investors should not be investing in commodities at the source, to begin with.

And the reason is obvious enough: commodities are a highly-volatile, unpredictable investment class. Consider the U.S. gasoline market: there are more than 20 variables that can affect the price of regular unleaded gasoline. Natural gas has almost as many variables. ETFs do very little to change the above. Don't misunderstand: ETFs are not gimmicky, but they are quirky.

In other words, typical investors should limit their investments to stocks, corporate and municipal bonds (including federal bonds), mutual funds, FDIC-backed savings, and perhaps a modest amount (2-10% your portfolio) of gold. And by gold, Money Matters means gold bars, not the ETF Spider Gold Trust (GLD). Ask your local banker or accountant about how to buy bars.

The better investment – stocks or ETFs?

Now, if you’re interested in investing in commodities, just do it conventionally, via stocks, based on your risk tolerance. Invest in a pure-play or near-pure play stock that does not exceed your risk tolerance.

Further, think long-term: at least 7-10 years. Money Matters does not recommend attempting to try to time the market, or rotating out of stocks after a short investment period. As the grandfather of one Money Matters Editor said frequently, “Don’t run for cover every time the market hic-cups!”

For example, if you can tolerate moderate-risk and want to invest in oil/natural gas, consider: Exxon-Mobil (XOM) or ConocoPhillips (COP). Both are currently at bargain prices. If you can tolerate high-risk, consider Southwestern Energy (SWN).

If you can tolerate moderate risk, and you’re looking for a copper/gold play, consider Freeport (FCX). For a potash play, consider Potash (POT) or Mosaic (MOS).

Again, Money Matters underscores the need to think long-term, at least 7-10 years. Money Matters won’t recommend a publicly-traded company or investment that does not have a strong prospect to remain in business and thrive.

Investing in commodities via stocks may not be as glamorous or as sexy as the ETF fad, but long-term, Money Matters argues your portfolio will look a whole lot more attractive.