Understanding the Commodity ETF

Investing in a commodity ETF is one of the most popular ways to invest in today's market. The ETF is a very unique investment tool that gives you a lot of options. There are currently over 800 ETFs in the marketplace today and many of those are made up of commodity investments. While many investors have heard about commodity ETFs, they may have no idea how they work. Here are the basics of the commodity ETF and why they may be a solid investment for you.

What It Is

An ETF is a type of diversified investment that is much like a mutual fund. However, the way that it is run is slightly different than a mutual fund. For one thing, an ETF is not as actively managed as a mutual fund. They start out with a company that owns many shares. They organize these shares into an ETF and investors start to purchase shares of it. The fund managers usually have a goal to mimic the returns that come with investing in a particular commodity. For example, if the price of oil increases, those that own shares in an oil ETF should profit.

Benefits of Commodity ETFs

You might be wondering why anyone would want to invest in a commodity ETF instead of directly investing in a commodity. The main reason is that it is much more simple to invest in an ETF. When you buy an ETF, you have a share in a portfolio of stocks in a particular sector. You can buy and sell that share whenever the stock market is open. If you want to take out an option on an ETF you can. If you want to sell them short, you can do so. The flexibility is unparalleled in the industry. Your alternative would be to take out a futures contract that can be very confusing. You might not fully understand how futures work and end up losing money. You would also have to work with a broker that deals in futures instead of your normal stock broker.

ETFs are also much more safe than other commodity investment alternatives. When you buy an ETF, you are diversified over the entire industry. If you invest in a particular company in the industry, they might go under. For example, you might invest in a particular oil company. That company struggles and eventually closes because they did not find any new oil deposits. However, the industry as a whole was going up at the same time.

With an ETF, you can not lose more than you originally invested. With futures contracts, this is not the case. You could actually have to come up with more money at the end of the contract. You could also be forced to take delivery of the commodity that you bought with your contract. More than one futures investor has been burned with this type of investment strategy. ETFs are much safer and can present you with solid returns. 

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