What role do commodities play in a diversified investment portfolio?

Commodities serve a significant role in a diversified investment portfolio primarily as a risk diversifier and inflation hedge. By including commodities, investors can reduce the overall risk of their portfolio because their price movements are often not closely correlated with traditional asset classes such as equities and bonds. This lack of correlation means that when stocks or bonds perform poorly, commodities may perform well or remain stable, thus providing a stabilizing effect on the portfolio.

Additionally, commodities tend to perform well during periods of rising inflation. As prices increase, the value of physical assets like gold, oil, and agricultural products typically rises as well, which helps to preserve purchasing power. This feature makes them a valuable addition for hedging against inflationary pressures that can erode the real returns of stocks and bonds over time.

In contrast, options that emphasize guaranteed income or leverage do not align with the intrinsic characteristics of commodities. Commodities are inherently volatile and do not provide fixed income streams like bonds or certain stocks might, nor do they typically enhance returns through leverage in a stable manner. Also, commodities should not replace equities and bonds but rather complement them, as they collectively contribute to a well-balanced investment strategy.