Stocks, commodities and other investment products rely on a particular benchmark such as the Standard & Poor’s (S&P) 500, or the Dow Jones Industrial Average (DJIA). But what is the difference between index investing and commodity investing?
Investing in an index, like the S&P 500, can be simple. The index tracks the performance of stocks listed in large, publicly traded companies. So, like a stock, you can buy a share of stock in a company that has been listed in one of the largest stock exchanges.
But index investing goes beyond stock market indexes. Some indexes that track individual stocks include oil and natural gas stocks, telecommunications stocks, precious metals, and technology stocks.
For investors, indices track stocks that have some similarities, but not all. While the DJIA doesn’t include the energy industry, Dow Jones Industrial Average includes oil and natural gas, but not other industrial industries.
These types of indices don’t really allow you to trade directly against crude oil, natural gas or any other type of energy. Stock prices may be based on speculation about when the company might be able to find new supplies, but they are not able to be traded until the company reports its findings. They are dependent on speculation to move forward with their production.
Other types of indexes offer a different sort of product. Rather than buying shares of a single company, these types of indexes are a grouping of companies based on their industry.
For example, one such index is the Texas Natural Gas Association. This oil and natural gas industry organization provide information about the performance of natural gas stocks over time. This gives investors an opportunity to purchase stock in different gas companies that have a connection to a specific sector.
Those in the know use this information to make a lot of money by knowing which companies in a sector are doing well and which aren’t. They usually prefer the right industry-based indexes, since oil and natural gas are just one of several industrial sectors that are based on a particular industry.
Another advantage of index investing is that you can focus your investing on a relatively small number of industries that are closely related. If there is an oil or natural gas company in every sector of the index, it means that you will invest in dozens of different companies. This is something you would never be able to do if you were buying shares of oil and natural gas stocks.
But then again, there is another factor that makes index investing a superior commodity investment to commodity investing in general. Investing in a commodity index is cheap because the costs of manufacturing the raw materials for the index are reduced. You could compare this to a shorting, where you can speculate that a stock will fall, and buy it when it falls.
Since commodities are a lot cheaper than stocks, this reduces the cost of index investing. One disadvantage of this is that stocks tend to be concentrated in a few large companies, so it’s harder to determine which companies are most likely to stay in business for a long time.
This makes commodity investing more suited to speculative investors, rather than those looking for steady, consistent profits. It also makes it more costly to trade compared to index investing.