In: Categories » Legal and finance » Stocks and mutual funds » Types of Mutual Funds ~ Open End and Closed End funds
| There are essentially two types of mutual funds: open-end funds and closed-end funds. Most mutual funds you'll hear about are open-end funds. Open-end funds can issue and sell new shares to the public as long as there are people willing to buy them. In other words, the pool of investors can grow indefinitely for an open-end fund. There are both pros and cons to this ability of the fund to grow. The main advantage is that a large fund has the resources to increase diversity and, therefore, protect its shareholders from being adversely affected by a drop in any single stock or even a single industry. But that same "larger pie" situation precludes a larger fund from benefiting in a dramatic way .from again in any individual security or selection of securities within the fund. For example, if a large fund has 5 percent of its holdings in the healthcare sector, while a smaller fund has 25 percent of its investments in healthcare companies, a big gain in the healthcare stocks would have a much greater positive effect on the smaller fund than the larger one. Conversely, should healthcare take a beating, shareholders in the smaller fund would feel the impact more keenly than those in the larger fund. When an open-end fund sells shares, it's issuing new shares. This is called a primary distribution, and because these are new shares, the Securities and Exchange Commission (SEC) requires the fund to offer all potential investors a prospectus. This is a document detailing data about the fund's financial soundness, as well as its purpose and strategy. I'll take you on a tour of a prospectus a little later on. When you buy shares in an open-end fund, you're buying new shares directly from the fund. When you sell shares, you are selling them back to the fund, not to other investors. When you invest, you are increasing the fund's asset pool, and when you sell back shares, the money comes out of the asset pool to pay you back. You'll generally have your money within a day or two of selling your shares. Closed-end funds, on the other hand, issue a specific, limited number of shares. These shares are then traded like stocks, on exchanges, and their value -from day to day - is determined by marketplace supply and demand. With open-end funds, the value of your shares is determined by the collective value of the underlying investments being made by the fund manager. But the market value of a closed-end fund share is primarily based on the demand ( or lack thereof) for the shares in the fund itself. This can work in your favor if the fund is doing well and demand is high. However, you could also find yourself in a situation where -even though the securities held within the fund are doing well -the demand for shares in the fund is weak, causing the market value of your shares to drop. The value of a mutual fund share -whether the fund is open-end or closed-end - Net Asset Value, or just NA V. The NA V is simply the total assets of the mutual fund divided by the total number of shares outstanding. If the fund has assets of $100 million, and there are a million shares distributed, each share has a NAV of $100. is its When demand for shares in a closed-end fund is not strong, shares will trade at a discount off the NA V. If demand is high, shares in the fund will trade at a premium above the NA V. Trading closed-end fund shares takes more skill and knowledge than does open-end fund trading. If a closed-end fund is trading at a premium, you must know whether market circumstances justify the higher price. If shares are trading at discount, you must know if it's enough of a bargain.
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