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Bloomberg

Hedge the cost of gas by adding commodities ETFs to your portfolio.

The recent turmoil in Iraq led many forecasters to predict that oil and gasoline could be headed for a substantial price increase. Jay Leno once joked, “Gas prices continue to rise. At the gas station near my house they have a slot for your credit card and one right next to it for your 401(k).”

The price of oil can be very volatile. Oil prices have a history of price spikes that are associated with geopolitical unrest. In 1979, the price of crude doubled to $38 per barrel. Using an inflation adjustment based on CPI data from 1946-2014 that equates to over $115 per barrel in today’s dollars. Oil spiked again in 1990 during the Gulf War. In June 2008 oil reached an all-time high when it averaged an inflation-adjusted price just over $135 per barrel for the entire month.

Over 30 years ago, back in 1983, Dr. John Lintner of Harvard University did a study on asset allocation and concluded that investors could achieve superior portfolio diversification by adding commodities to a traditional stock and bond portfolio. He said, Portfolios. including judicious investments. in leveraged managed futures accounts show substantially less risk at every possible level of expected return than portfolios of stocks (or stocks and bonds) alone.

Several years ago, it wasn’t that simple to add commodity exposure to your portfolio. You had to use a managed-futures fund and most of them had very high expense ratios. One of the most popular funds had a 4% up-front commission and a 4% annual trail. Their performance was good overall, but those expenses were a little bit on the high side.

The explosion of exchange-traded funds changed that. Investors today can add commodity exposure by using ETFs that have reasonable expenses and track the underlying commodity well. Be cautious when using ETFs, though. You need to know what you’re buying and how it works.

ETFs based on futures contracts can have roll costs that may have a decaying effect on the price. There is a difference between ETFs, exchange-traded funds and ETNs, exchange-traded notes that can be subject to additional credit risks of the issuer. Be extra careful using any kind of leveraged or inverse ETF, most of them are designed to be leveraged or inverse on a daily basis and the tracking error over longer time frames can be substantial.

The global energy picture has also evolved considerably. New drilling technologies have made previously inaccessible oil and gas deposits viable and proven the peak oil theory wrong.

Today, OPEC produces about 40% of the world’s oil. Canada’s proven oil reserves are second only to Saudi Arabia. The state of North Dakota is producing almost one million barrels a day and the U.S. is very close to energy independence. Renewable energy continues to play an increasing role as well. Last year, according to a study by BP, the demand for renewable energy hit a record of 2.7% of global energy consumption.Even if the conflict in Iraq continues and disrupts the supply chain, an oil spike may not be as damaging today as it could have been in the past.

Retirees who are concerned about the effects of inflation on their budgets can do some hedging by owning some of the commodities that have been subject to inflation recently.

For example in the U.S. the average price of gasoline has just about tripled in the last 15 years. There are commodity-based ETFs for oil, gasoline, natural gas as well as precious metals and food-based funds that can have low correlations to the stock market and can provide additional diversification and some inflation hedging to a traditional stock and bond portfolio.