How can I diversify my portfolio with futures?
If you’re like most investors, you may seek to diversify your portfolio with different types of assets—for example, stocks, bonds, mutual funds, and cash.
But did you know that futures can also play an important role in diversification? They have unique traits and uses that may help bring additional balance to your portfolio.
Here are the three main ways futures can help investors diversify:
- Diversification of access. Futures offer access to certain assets that are hard to find elsewhere.
- Diversification of exposure. Get direct market exposure to underlying assets (e.g., oil or precious metals), rather than secondarily through stocks or funds.
- Diversification of risk. Futures can be an effective tool to manage risk around pre-scheduled events that have the potential to move markets.
Access: Diversifying through less common assets
Futures offer access to a variety of assets you can’t get exposure to anywhere else—for instance, commodity products like soybeans, corn, and wheat, as well as energy products like oil and natural gas.
If you believe that the price of one of these products will rise, you might buy the corresponding futures contract. Or, conversely if you think its price will fall, you could sell.
For example, if you’re bullish on soybean prices, you may consider buying the CME soybean futures contract, an investment vehicle that provides an obligation to purchase 5,000 bushels of soybeans at the contract price. Such an investment can help you round out the composition of your portfolio by capitalizing on the price of soybeans going up.
Exposure: Diversifying through direct investing
Another way futures offer diversification is through pure market exposure—that is, the ability to invest in a specific commodity rather than in companies that conduct business related to it.
Here’s an example: Say you believe the price of oil will rise. Should you buy stock in oil companies?
While you certainly could, one thing to keep in mind is that most oil-related companies are in the business of exploring, extracting, and refining oil. Their stock prices won’t necessarily correlate with the price of oil itself.
If you’d like to diversify your portfolio with specific exposure to the price of oil, buying or selling oil futures may be one of the only ways to do so.
Risk: Diversifying ahead of market-moving events
Lastly, you can use futures to diversify portfolio risk associated with scheduled events—for instance, government-issued reports like unemployment and consumer prices. You can also use them to speculate (or hedge) before interest rate announcements by the US Federal Reserve.
When these reports are issued, the impact on stocks and interest rates can be immediate. Futures give you the opportunity to try to position your portfolio—ahead of time—by buying or selling contracts in the equity index and interest rate futures markets.
The bottom line
Futures offer a set of diversification characteristics not available elsewhere. This can provide greater flexibility and control—in either futures brokerage or retirement accounts.