Open-End vs. Closed-End Funds: Here’s the Difference and What To Know Before Investing
If you’re considering investing in a mutual fund or ETF, you might have heard the terms “open-end” and “closed-end” — and immediately scratched your head in confusion. Indeed, these are two distinct types of funds, with some major similarities, and some important differences. Both open-end and closed-end funds are usually professionally managed and include a diversified portfolio of stocks, bonds and other assets. In this way, they offer investors an easy way to diversify their own portfolio without researching dozens or hundreds of individual stocks.
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However, there are important differences between the open-end and closed-end funds that you should know about before investing your hard-earned money.
How Open-End Funds Work
Open-end funds most often come in the form of mutual funds. These types of mutual funds have an unlimited number of shares to sell directly to investors, excluding the need for an exchange. Open-end mutual funds can only be bought and sold at the end of each trading day, at their net asset value (NAV). This NAV is calculated at the end of the trading day by multiplying the number of shares of each fund-owned stock and bond by their closing price. Any liabilities of the fund is subtracted, and that total is divided by the number of outstanding shares. The result is the NAV, which becomes the fund’s price per share.
Open-End ETFs
Although mutual funds are the most common type of open-end fund, there are other types, most notably exchange-traded funds (ETFs). Although the structure of these funds is the same, there are key differences. For instance, unlike open-end mutual funds, which can only be traded at day’s end, buyers and sellers can trade open-end ETFs around the clock. For this reason, the price of open-end ETFs changes throughout the day.
Pros and Cons of Open-End Funds
Pros | Cons |
Price based on fund’s NAV | Traded only once per day (except EFTs) |
Potentially lower risk | Potentially lower returns |
Less volatility | Buying below NAV impossible |
How Closed-End Funds Work
Closed-end funds, including closed-end mutual funds, act more like an individual stock, but are still diversified in their holdings. These funds issue a fixed number of shares at an initial public offering (IPO) and then the fund’s manager buys assets to create its portfolio, based on the objectives of the fund. They are traded on exchanges and are priced not on the basis of their portfolio’s asset values, or NAV, but according to the laws of market supply and demand. Therefore, the price of closed-end funds can be more volatile than those of open-end funds. Importantly, because their value does not depend on their NAV, their price can trade above or below their calculated NAV, meaning gains and losses can be magnified.
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Pros and Cons of Closed-End Funds
Pros | Cons |
Traded 24/7 on an exchange | Possibly less liquid |
Potential for higher returns | Potential for magnified losses |
Potential to buy at a discount, below NAV | Can include higher fees |
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This article originally appeared on GOBankingRates.com: Open-End vs. Closed-End Funds: Here’s the Difference and What To Know Before Investing
