Counting on commodities as an investment

If only we’d had the foresight to stock up on lead. With just a few hundred tons of it we’d be sitting pretty today.

That’s right, the stuff of bullets and batteries. Lead prices have soared nearly 60 percent this year, due to increasing demand worldwide and production difficulties in China, the largest producer.

Lead is just one of a vast array of commodities that have done well in recent years. Corn is up nearly 70 percent in the past 12 months, largely due to its growing use to make ethanol for fuel. Soybeans are up nearly 40 percent in the past year. And so on.

The Dow Jones-AIG Commodity Index, though relatively flat recently, has produced average annual returns of about 9 percent over the past decade. It is composed of 19 commodities, from aluminum to cotton and natural gas to zinc.

Should small investors try to get in on the commodities boom?

Many are, using a battery of products that relieve you of the need to own a grain silo, warehouse or cattle ranch. Commodities investing gets easier by the day, it seems, with new mutual funds and exchange-traded funds that are a lot simpler to handle than futures contracts.

Still, commodities are not for the faint hearted. At the moment, the overarching question is: Is it too late? Anytime an investment has had a big run-up, as commodities have over the past few years, a new investor risks buying at the peak and losing money when prices pull back.

That said, many experts do believe that commodities deserve a place in the small investor’s long-term portfolio — generally no more than 5 to 10 percent.

Commodity prices are notoriously fickle, as they are driven by international forces that are devilishly hard to fathom. They are influenced by everything from rainfall to environmental and health issues to international relations.

Right now, for example, oil prices are being buoyed by a workers’ strike in Nigeria and Iran’s soured relations with the West.

But there’s a good side to this. Because the factors driving commodity prices are different from those governing stock prices, commodities often rise when stocks fall, and vice versa. That makes commodities a good way to diversify a portfolio, or spread out risk.

A recent study by finance professors Gary Gorton of the Wharton School and K. Geert Rouwenhorst of Yale found that a basket containing 40 commodities would have returned an average of 10 percent a year from 1959 through 2004, about the same as the Standard & Poor’s 500 index of large-company stocks. Commodities tended to do well when stocks were sagging, the professors found, because commodities benefit when inflation is high, while inflation hurts stocks.

So how do you invest in commodities?

The purest way is through futures contracts. These are standardized agreements to buy or sell fixed amounts of given commodities at a set price on a future date. A contract for pork bellies, for example, calls for the purchase or sale of 40,000 pounds of bacon.

If you invested in a contract to buy pork bellies, you would hope for bacon prices to rise, driving up the value of your contract. By investing this way, you would not have to take delivery of all that bacon. You would simply buy and sell the contracts.

But this is tricky. Because a futures contract expires on a set date, you can’t simply wait out a downturn as you can with stocks. Futures trading is done through a “futures commission merchant” or FCM, which is similar to a stock broker. You can find them with your search engine, but first read the cautions listed by the U.S. Commodities Futures Trading Commission.

If you want to dabble in futures, start small and avoid leverage, which means borrowing from the FCM the bulk of the money you invest. It can supercharge your gains – or wipe you out if you bet wrong.

Another approach is to hire a Commodity Trading Advisor, or CTA, an expert who will trade futures on your behalf, or to use a Commodity Pool Operator or CPO, who will pool your money with that from other investors, who will share the profits or losses. Bone up on this industry through the National Futures Association Web site.

The simplest way to invest in commodities, and probably the best for small investors, is to pick a commodities mutual fund.

One of the best known is the PIMCO CommodityRealReuturn Strategy Fund, designed to track the Dow Jones-AIG index. It’s up about 5 percent this year, while S&P 500 funds are up more than 8 percent

Another is the Oppenheimer Commodity Strategy Total Return Fund, which tracks the energy-heavy Goldman Sachs Commodity Index and is up about 3 percent this year.

Check out these and other commodity funds at the Web site of market-data firm Morningstar Inc. Key either of those ticker symbols into the Similar Funds function under the Tools button and you’ll generate a list of nearly 40 commodities funds. Be sure to read Morningstar’s analysts reports for a discussion of risks before investing, and watch out for high “loads” or sales commissions.

There also are a growing number of exchange-traded funds tracking commodities. The best known is the PowerShares DB Commodity Index Tracking Fund, which follows the Deutsche Bank Commodity Index, composed of crude oil, heating oil, aluminum, gold, corn, and wheat. It’s up about 4 percent his year.

A similar product is the exchange-traded note, such as the iPath Dow Jones-AIG Index Tracking ETN, a product of Barclays Bank, which promises to match the return on the Dow Jones-AIG Commodity Index, less a 0.75 percent annual fee.

This and other ETFs and ETNs can be purchased through a broker, just like any stock. On the Morningstar site, go to the ETF screening function under the ETF button and run screens for natural resources and precious metals funds. You’ll have to sift the results to find ETFs that invest directly in commodities, typically through futures contracts, rather than funds that buy stocks in natural resources or mining companies.


On the other hand, those stocks-based ETFs are not a bad idea. A fund containing oil-company stocks is likely to mirror the rise and fall of oil prices, for example. (By the way, there is a class of stock-like products called Master Limited Partnerships that invest in commodities infrastructure such as oil and gas pipelines. Examples are Kinder Morgan and Enterprise Products. They’re worth a look)

Whatever approach you choose for commodities investing, start small. Commodities are volatile. And once again, it’s always risky to jump into an investment after it’s had a big run-up.

By Jeff Brown
MSNBC contributor
© 2007 MSNBC Interactive

Five tips for young investors

You’re a twentysomething, just out of school or a few years into working life. It’s time to start some serious investing.

That’s because time is the investor’s best friend, and you have plenty of it — perhaps two decades to save for a child’s college costs, and probably four decades to build a nest egg for retirement.

I know — retirement seems eons away. And thinking about it makes you feel so settled and middle-aged.

But look at it this way: If you invest a little each month starting now, you won’t have to invest as much as you would if you were to wait another 10 or 20 years to get going.

Imagine, for example, that you want to have $1 million by the time you retire in 40 years. That would be enough to provide an annual retirement income of $40,000 for the rest of your life.

But in fact, you’ll need $3.26 million, because if inflation averages 3 percent a year, that's how much it will take to buy what $1 million buys today. The $3.26 million should produce an annual income of $130,000 — equal to $40,000 in 2007.

Start investing now and earn an average annual return of 10 percent — ambitious, but possible — and you’d have to invest about $7,400 a year to get to $3.26 million in 40 years. But if you wait 10 years to start investing you’ll have to set aside nearly $20,000 a year.

Start early with whatever you can afford. It will make life much easier later.

So what are the key things to know as you launch a long-term investing plan? Here are five tips:

Stocks, stocks, stocks
Stocks are riskier than bonds or bank savings, so in any given year you could lose money. But overall, the stock market doesn’t often lose money over periods longer than five years, because there are fewer losing years than winning ones.

Over long periods, returns in the stock market have averaged about 10 percent a year, while bonds earn a little over 5 percent. Cash, such as bank accounts or money market funds, averages about 3 percent

Look at mutual funds
Though the stock market offers good returns over time, many individual stocks lose money and never recover.

You would need at least 20 or 30 different stocks to safely “diversify” your money — spread it around to reduce risk. To find them you might have to read prospectuses, annual reports and news accounts on 200 or 300 stocks. Even if you know enough to do this — and most individual investors don’t — it’s an enormous amount of work.

Fortunately, we have mutual funds, which are investment pools run by professionals. Even if you have just a few thousand dollars to invest, with a single fund you can spread your money among dozens of stocks, sometimes hundreds. For a small fee, the fund manager does all the hard stock picking. One of the best place to research mutual funds is at Morningstar. Other financial Web sites like Yahoo Finance and Microsoft's MSN Money offer tools to evaluate mutual funds. (MSNBC.com is a Microsoft-NBC Universal joint venture.)

Focus on fees
The average stock-owning mutual fund charges investors annual fees equal to about 1.3 percent of assets — $1.30 for every $100 in your account. That little bit adds up. If your fund held stocks that returned 10 percent, the fee would cut your fund’s return to 8.7 percent. Instead of making $10 for every $100 invested, you’d make $8.70. You’d take a 13 percent pay cut.

Suppose you invested $1,000 today in a fund that earned 8.7 percent once fees were figured in. You’d end up with about $28,000 after 40 years. Now suppose you can find a fund owning the same stocks but charging only 0.2 percent. Your $1,000 will grow to about $43,000.

It’s an enormous difference. That’s why millions of investors turn to index-weighted funds that charge 0.2 percent or less. Instead of trying to find hot stocks, they simply buy and hold the stocks in a broad market index. The most popular track the Standard & Poor’s 500, which invests in the 500 largest U.S. companies, but there are many others.

Many studies have shown that index funds actually beat most “managed” funds over time, because most fund managers can’t successfully pick enough winners to overcome the damage from their high fees. Index funds also tend to produce lower annual tax bills. And because their investing strategy is essentially automated, you don’t have to worry that your fund manager will quit or retire

Minimize taxes
Since taxes chew away at returns the same way fees do, savvy investors use a variety of tax strategies.

The best options are the 401(k) or similar retirement plans offered by millions of employers. Your contributions are subtracted from your taxable income. In other words, if you put in $1,000 you’ll save $150 in federal income tax up front, assuming a 15 percent tax bracket.

Also, there’s no annual tax on investment profits, meaning money that otherwise would be used to pay taxes can instead keep growing as an investment. Taxes are paid when money is withdrawn in retirement.

Stick with it
Investing in stocks is a long-term strategy, not something you do with next month’s rent money. If you can weather the downturns you should be pleased with the results.

But remember, when you hear that stocks have returned an average of 10 percent a year, it refers to investments that were left alone, with all dividends and other earnings reinvested. If you make 15 or 20 percent one year, leave it all in the account to continue growing. Don’t take out the “extra” earnings to spend, because they’re needed to offset the years when you make less than 10 percent.

By Jeff Brown
MSNBC contributor
© 2007 MSNBC Interactive

External Experts Advice

Lethal mistakes for real estate investors

1. Planning as you go.
Andy Heller, an Atlanta-based investor and co-author of "Buy Even Lower: The Regular People's Guide to Real Estate Riches," says lack of a plan is the biggest mistake he sees new investors make. They buy a house because they think they got a good deal and then try to figure out what to do with it. That's working backward, Heller says. "First, you find the plan," he says. "Then you find the house to fit the plan. Pick your investment model, and then go find property to match that. Don't find the strategy after you find the home."

The problem is that most people look at real estate as a transaction instead of as an investment strategy, says Doug Crowe, a Chicago-based real estate investor and speaker. "People fall in love with a property," says Crowe, who is managing director of Springboard Academy, the nation's only real estate academy for investors. "I say, 'Who cares about the property?' I fall in love with a motivated seller."

The number is the number, and you don't go above that, he says. The best way to solve the problem is to have lots of activity and make offers on multiple properties. Then you don't care which one you get -- as long as the numbers work out in your favor.

2. Thinking you'll "get rich quick."
That kind of wrong-headed thinking is fueled by "these self-appointed gurus who have infomercials and make it sound so easy to get rich in real estate," says Eric Tyson, co-author of "Real Estate Investing for Dummies." It's not easy. It's a good long-term investment, but so is putting your money in a mutual fund, which is a lot easier. "These gurus don't talk about all that hard work. You have to be smart, you have to be willing to work, and you have to understand your risk tolerance."

3. Playing Lone Ranger.
A key to success is building the right team of professionals. At the very least, you need good relationships with at least one real estate agent, an appraiser, a home inspector, a closing attorney and a lender, both for your own deals and to assist with financing for prospective buyers. In the remodeling and maintenance segment of the business, the team includes a plumber, an electrician, a roofer, a painter, a heating and air conditioning, or HVAC, contractor, a flooring installer, a lawn maintenance service, a cleaning service and an all-around handyman. You can't build a business as an investor if you're spending all your time fixing leaky faucets and putting up ceiling fans.

4. Paying too much.
Heller says the biggest reason investors don't make money is simple: They pay too much for the properties. "The profit is locked in immediately once the investor buys the property," he says. "Due to mistakes in the analysis, the investor pays too much and then is surprised later when he doesn't make any money."

5. Skipping homework.
You wouldn't think you're qualified to perform open-heart surgery without years of education and training. Yet many wannabe real estate investors don't think twice about taking their financial lives in their hands without even cracking a book. Educate yourself before you put your family's financial security on the line. Read articles, check out books from the library and look for a local chapter of the National Real Estate Investors Association. Speakers at monthly meetings cover everything from buying foreclosures to screening tenants. If you can't find a local chapter, find out who owns a lot of rental properties in the area, call him up and offer to pay for an hour or two of his time to find out whether this is a good career for you

6. Ducking due diligence.
Investors often have to move very quickly on their deals. That doesn't mean they sign a contract and write a check without plenty of research, though. That's where a lot of newbies trip up, says Houston-based real estate agent Laolu Davies-Yemitan. They don't do their due diligence about the deal, the costs or the market conditions, and they wind up draining their personal savings because the house needs extensive repairs or they can't sell it. "Sometimes, new investors are buying property just based on the idea that the property is going to appreciate," he says. "Usually, they don't have any information to substantiate that."

7. Misjudging cash flow.
If your strategy is to buy, hold and rent out properties, you need sufficient cash flow to cover maintenance. "People think they can get a property manager," Tyson says. But many have never interviewed a property manager and have little idea about how they work. Most managers, for example, are reluctant to take on one single-family home or a duplex, he says, preferring larger complexes, and fees of 7 percent to 10 percent of the monthly rent are common. "It's a huge expense," Tyson says. "I can put my money in a mutual fund and it costs a half-percent a year."

Davies-Yemitan agrees. It's not uncommon for a property to sit on the Houston market for 90 to 120 days before it's leased, he says. Meanwhile the owner has to pay the mortgage, the taxes, the insurance, the cost of advertising and homeowner or condo association dues, he says. If the owner hasn't budgeted for that, an asset can quickly become a liability.

8. Lowering the volume.
If you're working on one deal at a time, Crowe says, you're doing transactions, not running a business. You need a steady pipeline of prospective deals; sufficient volume will weed out the marginal deals and let the good ones rise to the top.

9. Painting yourself into a corner.
Many people buy a property and get stuck with it because they only have one exit strategy. They're going to sell it or they're going to rent it out. What if it doesn't sell? What if the rental market stalls? Always have two, if not three, ways to get out of any deal. For example, if plan A is to rehab the house, put it on the market and resell it, then plan B could be to offer a lease-purchase to a buyer. Plan C might be to hold the house and rent it out. And as a plan D, there is the wholesale option, which would involve selling to another investor at a below-market price. Hopefully, you'll still make a profit, but at the very least, you'll cut the losses you're taking every month in carrying costs.

10. Miscalculating estimates.
Crowe tells his new rehabbers that after they've done their homework, they should double the amount of time and money they think it will take. If they can still make money then and they might be able to rent it out, it's a good deal.

An extract from Bankrate, Inc