Commodities Investing

(MoneyWatch) 

Should I invest in commodities like oil and gold?

Maybe — but only with a small portion of your portfolio.

There are three main arguments for investing in commodities. The first is diversification: commodity prices often move in different directions than stocks and bonds, so they can help smooth out a portfolio's returns. Reason two is to protect against a spike in inflation, because costs of raw materials tend to rise at least as fast as overall prices when inflation heats up. The final rationale is to guard against the possibility that the financial system will fall apart, in which case hard assets probably would hold their value better than financial assets.

Commodity prices can be outrageously volatile, however. Take oil prices, which dropped about 75 percent during the last six months of 2008. What's more, commodity prices can stagnate for decades: Gold hit $875 an ounce in 1980, and didn't reach that level again for nearly three decades. After adjusting for inflation, gold remains at less than half its 1980 peak, despite recent gains.

So what to do? You may want to keep 5 percent or so of your portfolio in commodities — but don't bet the farm on them.

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