Differences Between Open-End and Closed-End Mutual Funds
Open-end mutual funds are often referred to as just mutual funds, while closed-end mutual funds are referred to as closed-end funds, or CEFs. Both open-end and closed-end mutual funds may offer attractive benefits for individual investors. It's important to know both the similarities and differences when selecting investments for your portfolio:
- Diversification: Like open-end mutual funds, CEFs may minimize risk of an individual investment through diversification because CEFs invest in many companies, industries, and markets. For individual investors, achieving similar asset allocation would involve building a portfolio of many different investments.
- Professional management: Both open- and closed-end funds are managed by portfolio managers who are assisted by a team of analysts. Together, they research the companies, industries, and markets in which the funds invest. Few individual investors can match the time and effort put in by professionals whose full-time jobs are to track investments and seek new opportunities.
- Economies of scale: By pooling money from investors and buying and selling securities in large quantities, fund costs may be considerably lower than they might be for an individual investor. In addition, bookkeeping, tax calculations, and other activities can be simplified for the individual investor.
- Buying and selling shares: Following an IPO, CEFs trade on exchanges. In this manner, buying and selling shares of CEFs is very similar to buying and selling stocks. An investor would need to establish a brokerage account and place trades through a broker or financial advisor. The investor buying or selling will likely pay a sales commission to a broker at the time of the transaction.
In contrast, the number of outstanding shares of an open-end fund changes due to issuances and redemptions. When an investor wishes to buy shares in an open-end fund, the fund issues the investor new shares. Similarly, when an investor wishes to sell shares in an open-end fund, the fund redeems these shares.
- Share price: The price at which an investor buys or sells shares of a CEF is the market price, as determined by demand and supply market principles. For example, if many investors wish to buy shares of a CEF and few shares are available for sale, an investor may be able to sell the CEF at a premium to the net asset value (NAV).
In contrast, the price at which an investor buys or sells shares of an open-end mutual fund is the NAV of the assets under management at the close of a given business day, plus any applicable sales charges.
CEFs may trade at a discount or premium to their NAV. (If the market price of a CEF is greater than its NAV, it is trading at a premium. If the market price is less than its NAV, it is trading at a discount.) A CEF is not required to buy back its shares from investors upon request.
Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses.