Commodity Funds

Investing in commodity mutual funds is a way to diversify one's portfolio while minimizing the risks involved in commodity futures to the individual investor. In the same way that managers pool the money of many shareholders to maximize the return on the stock market, commodity mutual fund managers use the resources of many investors to take advantage of benefits in changes in the commodities market. Commodities are an interesting variety of articles of trade, ranging from agricultural products to precious metals to energy futures. At times these items are traded in the spot market, where actual physical delivery of the product is generally expected. Other investors prefer to sell the futures contracts before the actual expiration of the agreement. These investors seldom take delivery of their investment. Instead, they profit from selling the contract at a rate that is beneficial to themselves when the commodity's value increases. Commodities invested in through tax free mutual funds allow the investor to realize a greater percentage of return on their investment, instead of watching a large bite being taken out of their profits by taxes. In each case, knowing more about the investment and reading the fine print of agreements made with brokers or managers can aid in choosing tax free mutual funds that are likely to bring the greatest return on the investment.

One thing that investors appreciate about commodity mutual funds is that they can be used as a hedge against stock market investments. When inflation rises, the earnings per share of stock goes down due to the increased cost of borrowing money. Commodities, on the other hand, tend to rise in price at this time. This allows the commodity investments to act as a moat around the investor, which inflation is not likely to broach. Commodities are not risk free, though. They are generally traded using a margin account. This means that the investor only needs a small percentage to hold the contract. While this can result in fantastic profits for some people, losses can be equally impressive and affect many others. For this reason, many advise that commodities comprise only a small portion of the investment portfolio.

A way to minimize the risk inherent in the commodities market is to invest in managed commodity mutual funds. Another option is to make up your own portfolio, utilizing funds made up of companies which are in the commodity business. Either way, the investor needs to carefully examine the company's history, requirements and fees. Of course, the investor seeks to choose those investments whose fees do not threaten to overtake the expected profits, and which have a solid rate of return. One caution in this regard: it is not a good idea to choose those whose managers trade too frequently. Although at first this seems puzzling -- after all, the more activity, the more chance of creating profit -- this precaution is due to the fact that excessive turnover is not the best policy. It can actually reduce returns in that any actual profit may be diminished due to the costs of each transaction. Also, this opens the investor up to additional capital gains taxes on the transaction.

One way to avoid the federal and state taxes which normally occur on investments is to choose tax free mutual funds. These are money markets which invest in companies which are exempt from federal taxes. These usually have a lower yield than regular mutual funds. Read the prospectus carefully and do the math to determine if the tax-free aspect compensates for, or even surpasses, this loss in yield. Note that even tax free mutual funds can leave a person subject to capital gains taxes. Also, check your state's regulations regarding state tax exemption using these types of investments. In general, this choice works best if you are able to leave the money untouched for a while. Early withdrawal penalties can be substantial.

Investors in 401k, 403b and IRAs can rest easier in that taxes on capital gains are deferred when they are paid from mutual funds held in these accounts. However, even for tax free funds, a high rate of turnover can still result in an average loss of about 0.7% per year. At first this may seem insignificant, yet the effect of compounding interest lost due to taxes and transaction fees over the years can greatly affect overall profits. Remember, if a person invests in a high turnover taxable account, he or she is the one who is going to be paying the taxes. The over-zealous manager, who may be more concerned with showing a high rate of return to attract future investors, may not be as concerned with the effects of taxes. Do not misunderstand -- a high rate of return is a good thing. In after-tax terms, though, profit may actually be higher from investments which have a lower rate of return yet do not lose profit due to too many transaction costs. Index funds may be a good choice. Because these funds do not turn over their holdings so frequently, there is minimal exposure to capital gains.

All of the above factors illustrate the need for the investor to recognize the responsibility to look carefully into the details surrounding his or her investments. If one intends to make a profit, some work may be required to become knowledgeable about various investment instruments. However, this is time well spent. Proverbs 22:29 encourages: Seest thou a man diligent in his business? he shall stand before kings; he shall not stand before mean men. Whether the investment is in commodity mutual funds or tax free mutual funds, paying attention to business will surely bring some type of profit. That much is guaranteed.