Is Investing in Commodities Only for the Brave?

Commodities have a reputation for being a risky asset. Many investors are simply scared of investing in this asset class. This fear is largely unfounded because, statistically speaking, there is no greater risk in investing in commodities than there is in investing in stocks.
For whatever reason, investors have shunned this asset class in favor of what they think are more “prudent” investments such as stocks. This is quite baffling because the performance of commodities in recent years has been superior to that of stocks. For example, between 2002 and 2005, the Dow Jones Industrial Average returned a respectable 7 percent. However, the Dow Jones-AIG Commodity Index, which tracks a basket of commodities, was up over 21 percent! In fact in 2002 alone, while the Dow Jones Industrial Average had negative returns (–7 percent), the Dow Jones-AIG Commodity Index had returns of 26 percent.
I once attended a lecture with a world-renowned market psychologist who made this simple argument: Investors are afraid of what they don’t know. Many investors will prefer to stick with an investment they know even if that investment doesn’t perform well for them. For example, during 2000 and 2001, the investing public lost a total of $5 Trillion in stocks (remember the bursting of the dot.com bubble?). And yet you never hear the kinds of warnings about stocks that you hear about commodities. Is this a double standard? You can judge for yourself.
I believe that many investors are afraid of commodities because they don’t know too much about them. However, I’m not denying that commodities present some risk — all investments do. So I give you some tools in the following sections to minimize and manage those risks.