Most financial advisers recommend capital diversification between two asset classes: stocks and bonds. But every now and then I see some financial advisers recommending two additional asset classes: real estate and commodities.
A common portfolio including those additional would look like this:
- Stocks: X%
- Bonds: X%
- Real estate: X%
- Commodities: X%
In previous articles I have explained why I don’t like investing in bonds. I think the opportunity cost is too high. In the long run stocks outperform bonds and stocks are NOT more risky than bonds, they are just a more volatile.
In previous articles I have also mentioned that I invest in real estate. In particular, I own a condo in the coolest neighborhood of Montreal. Obviously, I like real state as an investment. As long as the tenants pay the rent on time and don’t destroy your property, it’s a sweet business.
One asset class which I dislike worse that bonds is commodities.
what are commodities?
Commodities are standardized raw materials or products such as wheat, sugar, corn, coffee, cocoa, oil, gold, copper, etc.
How do people make money with commodities?
Investors speculate on whether the prices of any one of those commodities will go up or down. If they think the price of of corn will go up they buy corn. If they think they price of corn will go down they sell corn. If their speculation works out, they make a ton of money. If their speculation doesn’t work out, they lose a ton of money.
Why I don’t like commodities as a long term part of your portfolio?
Commodities is a zero sum game. For every trade there is a winner and a loser. If we add commissions into the equation, on the long run, investing in commodities is a losing game.
When you invest in stocks, you get dividends or the price of your stock goes up as the company retains earnings. See article on what kind of return to expect from the stock market.
When you invest in bonds, you get paid interest.
When you invest in real estate you get rent.
When you invest in commodities you get nothing.
Let’s say you buy a bar or gold. You hide it under your bed. 10 years later, you look under the bed and you see the same bar of god. You don’t see a bar and a half, you don’t see two bars, none of that… Your bar of gold has remained the same. You check the price of gold and most likely your bar of gold has increased in value at the same rate as inflation. Nothing more, nothing less. If your investment is going to grow at the rate of inflation, you might as well buy government bonds.
See article on why investing in gold is a bad idea.
There are similar scenarios for all kind of commodities. They have violent swings up or down, but if you look at any long term chart, on a 20 year period or longer, the value doesn’t go up higher than inflation.
My ultimate recommendation is to continue piling up your money in real estate and stocks. You will continue getting dividends checks or rent checks. Let the money continue working for you. 🙂