What are open-ended mutual fund & close-ended mutual fund?
Financial world and its terminologies can leave the most intelligent people baffled with its nitty gritties. To a layman it all appears the same until he/she dwelves deeper to create a portfolio of their own. We simplify the financial terminology to help you understand this not so complex world of finance easily.
What are open-ended funds?
Open-Ended Funds are simply put a category of the mutual fund where there is no restriction on the number of shares issued. For example, when Mr X purchases shares in a mutual fund, the number of shares overall increases. But when Mr X sells his shares, those shares are taken out of circulation and if required for large dealings the fund manager may have to sell some of the investments to pay off Mr X’s money.
Funds and their managers are prone to seeing a continuous entry and exit of investors as the funds sell their shares on a regular basis. Open-ended funds allow the opportunity of purchasing and selling shares even after the initial offering (NFO) period. This is applicable only in the cases of new funds as the shares are bought and sold at the net asset value (NAV) declared by the fund.
Mutual funds are different from stocks in all respects and hence unlike your stocks you will not be able to monitor them or trade them in the open market. While the transactions happen on a daily basis on the fund with the selling and buying of new shares, in proportion to the same the total value of the fund or net asset value (NAV) is repriced accordingly.
What are closed-ended funds?
While the open-ended funds and closed-ended funds look similar, they're very different. To be precise a closed-ended fund is more like an exchange traded fund than a mutual fund. Like ETFs they are launched in the market through an IPO in order to raise money and then trade in the open market just like a stock or an ETF. The shares issues by this fund are limited and their value is estimated on the basis of the NAV. Though the value of these shares is based on the NAV, the actual price of the fund is determined by the supply and demand, and therefore the price of trading always differ according to the real market value.
Close-ended funds give a high dividend and therefore attract more investors. However, investors need to understand that though the borrowed money produce big returns on investment, using borrowed money for investment can get the fund under intense pressure in the long run.
While open-ended fund products are a safe choice for investment than closed-ended funds, the latter offers lucrative deal in terms offering higher dividend payments and capital appreciation.
We advise investors to be careful and come to any decision post a thorough weighing of all the pros and cons.
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