Investing in futures can provide individuals the opportunity to diversify their retirement accounts by providing access to trade commodities, futures, and forex. While futures investing carries greater risks, it can also give investors flexibility and investment strategies beyond the stock market. Investing through a self-directed IRA can also provide tax advantages as trading profits will be tax-deferred (or tax-free through a Roth IRA).
What Are Futures?
Futures are defined as contracts obligating a buyer to purchase a specified amount of a physical asset such as a commodity or a financial instrument at some predetermined future date and price. On the flip side, a futures contract can also obligate a seller to sell a physical commodity or a financial instrument at a predetermined future price and date.
Contracts are often settled in cash, but in some cases the settlement can be the delivery of a physical commodity such as bushels of wheat or a specified number of live hogs.
Futures contracts are traded on exchanges like the Chicago Mercantile Exchange (CME) and others. Agricultural and livestock futures are a way for both producers and users of these physical commodities to hedge the price to help protect their profitability.
Futures contracts are a way for investors to speculate on the movement of the price of physical commodities, the direction of interest rate or stock index futures or the direction of various currencies relative to the dollar or other benchmarks.
Futures generally have a low correlation to traditional investments in stocks and bonds.
Types Of Futures Contracts
There are a number of different types of futures contracts available to trade on various exchanges.
Contracts based on agricultural commodities including:
- Cotton
- Corn
- Wheat
- Soybeans
- Sugar
- Lumber
Contracts based on precious metals including:
- Aluminum
- Gold
- Silver
- Other precious metals
- Copper
Contracts based on energy including:
- Oil
- Natural gas
- Heating oil
Commodities based livestock including:
- Cattle
- Hogs
- Pork bellies
Additionally, there are a number of contracts based on financial instruments, including:
- Stock indices
- Forex/currencies
- Treasuries
These and other futures contracts allow investors to profit from the price direction of the underlying commodities or other assets. Futures can also serve as an important hedging vehicle for farmers, manufactures and financial services firms.
How To Invest In Futures
Depending upon your knowledge and experience in trading futures, you can open your own trading account or trade them through a futures broker or other third-party.
You can also participate in futures trading via a commodity pool. These pools have similarities to mutual funds in that they pool the assets of a number of investors together to trade futures. The structures of these pools are often similar to hedge funds and other private equity investments.
What To Know Before Investing
Before investing you need to understand a few things about the futures contract you are considering:
- The unit of measurement for the contract.
- How will the trade be settled, in cash or the delivery of the physical commodity or livestock.
- The quantity of goods or units (for financial futures) covered by the contract.
- The currency the contract is denominated in and quoted.
- If appropriate, the grade or quality of the underlying commodity or livestock covered by the contract.
Futures In A Self-Directed IRA
Trading futures contracts within a self-directed IRA account could be an excellent way to diversify your retirement savings by using an alternative asset class.
Moreover, the tax-deferred (and tax-free if a Roth account) nature of an IRA can work well with the often-complicated tax structure of gains from trading futures contracts. Any profits are not subject to taxes until withdrawn in retirement.
As with any investment made via your self-directed IRA account, all funds used to trade futures must come from the IRA account. You should plan on having sufficient liquid assets available in your IRA to cover any potential margin calls. If there is a margin call or other shortfall that needs to be funded, personal assets cannot be used to remedy the situation. In addition, your broker cannot deduct assets from any personal accounts that you may hold with the firm. You can only make an IRA contribution or have funds transferred from another retirement account to deal with the situation.
Also, you should check with your broker or futures commission merchant to determine whether they have any restrictions on the types of trades that they allow with an IRA. For example, some brokers may not permit trading options on futures in an IRA while others may carry certain margin requirements.
