Closed-ended VS Open-ended Mutual Funds: Pros, Cons & Differences
Equirus Wealth
01 Feb 2023 • 4 min read
Mutual funds are investment instruments that pool money from multiple investors to purchase a portfolio of securities, such as stocks, bonds, and other assets. The portfolio is managed by a professional fund manager who invests the money on behalf of the fund's investors. The fund's returns are generated from the performance of assets in the fund and are shared among the fund's investors in proportion to their investments.
Mutual funds offer investors the opportunity to access a diversified portfolio of assets, which can reduce the risk of a single investment. They are also a convenient way for individuals to invest in the stock market, as they do not need to research and purchase individual stocks themselves. Instead, they can invest in a single mutual fund that provides exposure to a range of different assets.
Types of Mutual Fund
1. Close-ended mutual funds
Close-ended mutual funds are funds that are issued in a fixed number of shares, which are then traded on a stock exchange. These funds have a set maturity date and the fund manager can only issue new shares during the initial public offering. The price of close-ended fund shares is determined by supply and demand, like any other publicly traded security.
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Pros of Close-ended Mutual Funds:
Price stability: The price of close-ended fund shares is not directly tied to the value of the underlying assets, which means that it is more stable.
Higher returns: Close-ended funds have the potential to deliver higher returns due to the lack of constant buying and selling by investors, allowing the fund manager to focus on longer-term investments.
Active trading: Close-ended funds can be bought and sold like any other publicly traded security, providing investors with more flexibility and the opportunity to profit from market fluctuations.
Cons of Close-ended Mutual Funds:
Limited liquidity: Close-ended funds are not as liquid as open-ended funds, and it can be difficult to sell shares if demand is low.
Higher fees: Close-ended funds often charge higher fees due to the complexity of managing the fund.
Market risk: The price of close-ended fund shares is subject to market risk, and the value of shares can decrease if demand decreases or market conditions change.
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2. Open-ended mutual funds
Open-ended mutual funds, on the other hand, do not have a fixed number of shares. The fund manager can issue new shares as needed to accommodate new investors or redeem existing shares when investors wish to cash out. The price of open-ended fund shares is determined by the net asset value of the underlying assets in the fund.
Pros of Open-ended Mutual Funds:
Liquidity: Open-ended funds are highly liquid, and investors can redeem their shares at any time for the net asset value of the underlying assets.
Lower fees: Open-ended funds generally have lower fees than closed-ended funds due to the simplicity of their structure.
Diversification: Open-ended funds offer a diversified portfolio of assets, reducing the risk of a single investment.
Cons of Open-ended Mutual Funds:
Price fluctuations: The price of open-ended fund shares can fluctuate with the value of the underlying assets, leading to short-term price changes.
Manager discretion: Open-ended funds give the fund manager more discretion in choosing investments, which can lead to a higher risk of poor performance if the manager is not experienced.
Conclusion
In conclusion, both close-ended and open-ended mutual funds have their own advantages and disadvantages. Close-ended funds offer price stability, higher returns, and active trading, while open-ended funds offer liquidity, lower fees, and diversification. The choice between close-ended and open-ended funds will depend on an investor's investment goals, risk tolerance, and personal preferences. Ultimately, it is important to do your research and work with a trusted financial advisor to make the best investment decision for your financial future.
