Mutual funds can invest up to 50% of their net assets in derivatives. However, the mutual fund industry in the United States is not regulated as well as other investment options. The industry has been operating under the Investment Company Act of 1940, dating back to a time when derivative markets did not exist. Therefore, regulation of mutual funds' use of derivatives as an investment option is not up to date and designed to handle the current market. However, mutual funds can still be very conservative and generate great returns if you choose wisely.

What Are Derivatives?

Derivatives are financial instruments based on agreements or contracts with their values tied to underlying instruments, indexes or assets. Derivatives can include futures, forward currency contracts, options on future contracts, and interest rate swaps or credit default swaps.

Is It Safe to Invest in Mutual Funds That Deal With Derivatives?

Mutual funds are generally safe to invest in, even if they include derivatives in their portfolios. Check your mutual fund's prospectus to figure out the percent of its net assets tied up in derivatives. Review the company's website or the publicly available SEC forms and filings. If the fund has over 50% of its net assets invested in derivatives, you should probably take caution before you invest in the mutual fund. However, the good news about derivatives is that they can drastically boost returns. The disadvantage is that they are known to be quite risky, which is why hedge funds are well-known for using derivatives as an investment technique.

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