The main difference between a commodity vs. security lies in what you own. Commodities are raw materials and basic goods, while securities represent an ownership stake (e.g. stock) or a debt obligation (e.g. bonds).
As such, investing in commodities and securities can offer two different paths to diversification.
Both commodities and securities can be traded on market exchanges. Between the two, commodities are typically categorized as alternative investments to the traditional array of stocks, bonds, and cash many investors hold.
Understanding Commodities
What are commodities? The Commodity Futures Trading Commission (CFTC) recognizes three categories of commodities:
• Agricultural
• Natural resources
• Financial instruments
In simple terms, commodities are raw materials typically used in the production of other goods. Commodities are considered a type of alternative investment because these products — whether oil, corn, or copper — don’t move in sync with traditional stock and bond markets, and may provide portfolio diversification.
Types of Commodities
Broadly speaking, commodities may be classified as hard or soft. Hard commodities are mined or extracted, while soft commodities are produced through agriculture.
Examples of agricultural commodities include wheat, soybeans, corn, and livestock. Natural resource commodities include gold, silver, copper, and timberland investments. Financial instruments include U.S. or foreign currencies, or options and futures contracts that invest in an underlying commodity.
The Commodity Exchange Act (CEA) regulates the trade of commodity futures in the U.S. Trading futures commodities must generally be done through a commodity exchange, with some limited exceptions. The CEA also enables the CFTC to regulate the commodities industry.
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Understanding Securities
Now, what are securities? The term securities refers to a broad range of investments where there’s an expectation that value or profit will be returned to the investor. Examples of securities include:
• Stocks
• Bonds
• Mutual funds and exchange-traded funds (ETFs)
• Mortgage notes
• Promissory notes
• Limited partnerships
• Oil and gas interests
• Debentures
• Investment contracts
Stocks and bonds are among the most commonly traded securities. When you buy shares of stock you’re getting an ownership stake in the underlying company. Should the value of your shares increase you could sell them at a profit.
Bonds are a debt obligation between the bond issuer and investors. When you buy a bond, you agree to let the bond issuer use your money for a certain period. During that time you’ll earn interest, and when the bond matures you can reclaim your original investment.
Certain types of financial instruments are excluded from this list. Checks, bank accounts, and traditional life insurance policies don’t meet the definition of a security.
How Securities Are Regulated
The Securities and Exchange Commission (SEC) regulates securities trading in the U.S. Some of the most significant laws relating to securities include:
• The Securities Act of 1933
• The Securities Exchange Act of 1934
• Investment Advisers Act of 1940
• Sarbanes-Oxley Act of 2002
• Dodd-Frank Wall Street Reform and Consumer Protection Act of 20105
Many securities are publicly traded on market exchanges. The New York Stock Exchange (NYSE), for example, is the world’s largest stock exchange. Securities that do not trade on an exchange may be traded privately or over the counter. Over-the-counter trading relies on a network of broker-dealers to complete the sale or purchase of securities.
Comparing Commodities and Securities
Commodities and securities can be used to achieve different goals in a portfolio. Both allow for diversification but they differ in how they work, what you’re trading, and the associated risks and rewards.
Here’s a simpler way to think of the difference between a security vs. commodity. Securities often represent the end product, while commodities are the building blocks of that product.
For example, take a company that produces computer chips. If you invest in the precious metals used to make computer chips (e.g. gold, silver, platinum), you’re investing in commodities. If you buy shares of company stock, those are securities.
Here are some of the important things to know if you’re weighing security vs. commodity trading.
| Commodities | Securities | |
|---|---|---|
| Nature of the investment | Raw materials and basic goods | Stocks, bonds, mutual funds, investment contracts |
| Trading mechanism | Futures contracts and options can be bought and sold on a commodity exchange; commodity mutual funds and ETFs can be traded on a stock exchange | Publicly traded stocks and bonds can be bought and sold on stock exchanges |
| Potential Benefits | Portfolio diversification, potentially higher returns, inflationary hedge, potential insulation against market volatility | Potential gains through active trading, potential for long-term capital appreciation, potential for passive income from dividends |
| Potential Risks | Supply and demand, weather/climate conditions, geopolitical events can influence commodity pricing | Supply and demand, investor sentiment, economic conditions, interest rates, and company health can influence stock and bond prices |
| Regulatory body | Commodity Futures Trading Commission | Securities and Exchange Commission |
Investing in Commodities vs Securities
Purchasing physical commodities isn’t realistic for the average investor, as doing so requires you to store them (or pay for storage) until you’re ready to sell. Instead, commodities are typically traded through one of the following:
• Futures contracts
• Commodity mutual funds and ETFs
• Hedge funds (often the domain of high-net-worth investors)
Options and futures contracts are derivatives, meaning their value is determined by an underlying investment, i.e., the commodity you’re trading. Commodity funds and ETFs can offer exposure to a basket of investments, which may include individual securities.
For instance, rather than trading oil futures contracts, you might purchase an ETF that holds gas stocks. Or you could buy individual shares of energy stock if you prefer.
With securities, you have some of the same avenues for investing. You can purchase stand-alone stock shares or individual bonds. Mutual funds, an array of index funds, and ETFs can offer broad diversification. You could also trade stock options if you’re comfortable with speculative investments.
Whether it makes sense to choose a security vs. a commodity for your portfolio can depend on your risk tolerance and objectives.
Portfolio Diversification With Commodities and Securities
Commodities can offer exposure to alternative investments beyond traditional stocks and bonds. Thanks to options, contracts, and commodity funds you don’t need to purchase physical commodities. You can select which areas you’d like to target, based on whether you prefer hard vs. soft commodities.
You might choose to focus on a single category, such as agriculture. Or you might spread your investment dollars across agricultural commodities, natural resources, and financial instruments for a more well-rounded approach.
Diversifying with securities often means finding the right mix between stocks and bonds. Your optimal asset allocation may depend on your age, your time horizon for investing, and how much risk you’re comfortable taking. Within each securities category, you can decide how to invest based on:
• Whether you’re looking for a quick profit vs. longer-term gains
• Your preference for earning passive income from dividends or interest
• How much risk you need to take to achieve your goals
All investments carry some risk, though some are riskier than others. Commodities tend to veer toward the riskier side which is important to remember when deciding how to allocate your portfolio.
The Takeaway
The main difference between a commodity vs. a security lies in what you own. With commodities, you’re most often trading futures or options contracts for an underlying good, such as pork bellies, oil, or aluminum. With securities, you’re typically buying stocks or bonds, or derivatives contracts.
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FAQ
What is the difference between a security and a commodity?
The main difference comes down to what you’re investing in. With commodities, you’re most often trading futures or options contracts with an underlying raw material or good, such as pork bellies, oil, or aluminum. With securities, you’re typically buying shares of a company or funding bonds with the expectation of earning interest.
Can a commodity become a security?
A commodity can become a security if it meets the definition of an investment contract under the Howey Test. This test, which was formulated through a 1946 Supreme Court decision, defines an investment contract as being an investment of money in a common enterprise, with the reasonable expectation of profits due to the managerial efforts of others.
Is gold considered a commodity?
Yes, gold is considered a commodity. In terms of its uses as a raw material, gold is often a key element in jewelry production and electronics manufacturing. Historically, gold has also been used as a form of currency and is a form of legal tender in the United States, but it is not considered a security.
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