While sitting in a doctor’s office the other day, I happened across an article in Bloomberg magazine entitled “America’s Worst Investment” (magazine cover shown here) that explained why commodity ETFs were such a terrible investment vehicle for individual investors. Since Bloomberg is pretty reputable, and since I had previously invested (and lost money) in RJI, a commodity ETN (exchange-traded note) that tracks the Rogers International Commodity Index, of Jim Rogers fame, I was really interested in what the article had to say.
As I’ve posted here before, I’ve relied on ETFs quite a bit in the past to do the bulk of my passive, buy-and-hold investing. They’re an easy way to diversify and since most of them track indices, there’s not much to think about compared to the difficulties of evaluating an individual stock. After reading Jim Rogers’ books, I was interested in diversifying into commodities, and when someone finally came out with an ETN that reflected his index a couple of years ago, I bought in.
The Bloomberg article is quite eye-opening and explains why commodities ETFs that are based in futures can be a no-win situation for individual investors. You’ll have to read the article to fully grasp the pitfalls of these vehicles, but one vocabulary word I learned was “contango“, something I had never heard of. It boils down in essence to the nature of a futures contract. Unlike an option, where you have the right but not the obligation to buy or sell an underlying security, in futures contracts, you have the obligation to take delivery of the underlying security or good unless you rid yourself of that contract in some way.