Stocks and commodities are two very different types of investments, though both are traded on open exchanges most weekdays. In its most basic form, stock investing involves buying and selling of shares in corporations. In contrast, commodities investing involves buying and selling of futures contracts with publicly traded commodities. Because diversification matters so much in the land of investing, it is vital to understand how each of these forms of investments functions so that you can leverage them to their fullest.
Commodities vs. Stocks
Since stocks and commodities are very different financial products, including both of them in an investment portfolio can help you diversify your investments. Here are some key areas where commodities and stocks differ:
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- While you can experience both a stocks and commodities slump, they often peak and bottom out at different times.
- While stocks are focused on owning shares in a company, commodities are about investing in goods like agricultural products or metals.
- Stocks allow company ownership, while commodities do not.
- Stocks are traded in the stock market, while commodities are traded in the commodities exchange.
Stock Investing Basics
According to Investopedia, while there are more advanced methods of making money in the stock market, basic stock investing involves buying and selling of publicly traded shares. You can hire a brokerage and pay fees for portfolio management or perform your own research and invest through one of the many online self-service brokerages.
Individual investors, retail buyers, large mutual funds and even other companies invest in stocks to make money. Major public stock exchanges, including the New York Stock Exchange and Nasdaq, combined with a high volume of traders, make stock investing fairly liquid. You can get into and out of stocks within a few days – or even on the same day as a day trader.
Commodities Investing Basics
Commodities are physical goods produced in large quantities and easily distributed, which allows for stable investment activity. Minerals such as gold and silver, crops such as soybean and wheat, and various livestock are common examples of products traded through commodities exchanges. Investors make decisions based on expectations of future increases or decreases in the value of goods relative to the present-day value. The Chicago Mercantile Exchange is one of the largest exchanges through which commodities futures contracts are transacted.
Forbes reports that commodities are traded through futures contracts, which means investors buy or sell based on expected price points in the future. In stark contrast to stocks, commodities are traded on margin with little of the actual transaction amount being held in the trader's account at the time of purchase. With margin trading, risks are amplified, because traders will often invest much more than the value of their accounts. Sharp movement in prices leads to a high risk-to-reward proposition.
Though many types of people and companies invest in commodities, futures contracts are often used by farmers, producers and other agribusinesses as a way to hedge against potential losses stemming from actual business activities. If producers are concerned about actual prices of a crop dropping before distribution, for instance, they can trade in futures contracts to mitigate losses.