As an investor, you probably know what mutual funds are. Simply put, mutual funds are companies that pool money collected from different investors and utilize these resources to buy different assets. Open-end funds are the most common type of mutual funds.
In today’s article, you will find out more information about them, including their advantages and disadvantages. Furthermore, you will find a comparison between open-end and closed-end funds.
What Are Open-End Funds?
As their name suggests, open-end funds are “open” for investment at all times.
This means that these mutual funds offer their investors shares without limits – you can sell and buy whenever you want. If you want to purchase shares from the fund, they will sell them to you. Also, if you wish to buy more shares, the open-end fund will purchase them back from you. Usually, these funds are active, but sometimes may include passive investments, for instance, track index’s performance.
Open-end funds are very convenient for investors since they satisfy their current needs at once. An investor can buy shares even after the initial offering period and their price is determined by the fund. This price is known as net asset value.
Most of the open-end funds are actively managed, which means that a team of professionals takes care of the investment strategy. However, some of them are passive, for instance those tracking indexes as mentioned earlier. If the fund’s total assets have reached an amount that prevents the management from expanding and achieving their goals, the company will close for new investors.
At present, there are more than 8,500 open-end funds whose total net assets exceed $14 billion. In comparison, all closed-end funds operate with almost $300 billion and the ETF (Exchange Traded Fund) market is “only” $2.2 trillion.
Advantages Of Open-End Funds
Based on their net asset value, open-end funds pricing is preliminary set and determined and does not fluctuate depending on the market.
Of course, the latter provides investors with greater chances of potential profit. And even though their potential return is limited, open-end funds are reliable and usually, their value rises with time, unlike close-end funds which follow the opposite trend.
Liquidity is one of the most important aspects to investors.
The ability to easily buy and sell assets is very important if you want to survive in this game. Open-end funds tend to be highly liquid because they give investors the opportunity to sell their shares at all times. Usually, most funds buy your shares by the end of the day or the following day. Other investments are not as liquid and often investors cannot sell the acquired assets. What’s more, other funds might even charge investors if they preliminary liquidate their shares.
Always trust the experts!
Open-end funds, just like most of the other mutual funds, have a professional management team that chooses, compares, buys and sells stocks and securities. This is their job and they have all the time to do research, analyze assets within a market segment and make the right decisions. They can also find cheap securities or over-priced stocks and bonds, which they will convert into a profitable move.
Fund Families Option
A fund family is a group of several mutual funds that has the same “parent” company. Why do mutual funds do this and how is it related to the topic?
To begin with, each mutual fund has its own objective. For instance, some of them are income-generating funds, while others are much riskier aiming at higher returns – buying volatile stocks, for example. Imagine that this year you want to have an additional, steady income, but next year, you want to experiment with something more exciting and riskier as an option. Then, you will have to buy shares in one fund and sell them in another. This whole process has its serious drawback – you have to pay commissions and fees.
Fund families combine funds with different objectives, and an investor can easily transfer their shares and money from one of them to another without hefty commissions and load fees.
Disadvantages Of Open-End Funds
Open-end funds have their drawbacks too.
One of the main advantages of these funds is their liquidity, most probably you remember. But it comes at a price. In order for them to do that, companies need to sell their assets and pay their investors. This will result in capital gains that are not exempt from taxes. The funds, however, do not pay taxes on their capital gains but rather the shareholders. Usually, this happens when they receive their distributions, and investors should pay income taxes on them.
Another disadvantage is the fact that shareholders can buy or sell assets only once each day. In this regard, close-end funds are more attractive because they work like exchanges and you can trade as many times as you wish in a single day. This means that you can make a bigger profit or avoid potential losses.
Closed-End Vs Open-End Funds
Even though they might differ from one another significantly, the main difference is the way they function. Or, simply said, the way they sell and buy securities to investors. Below, I will list the things they share in common and all the main differences they have.
- Professional management – both types have management teams that make all the investments and develop the investment strategy and objectives.
- Diversification – both types actively buy different types of stocks and securities so that the portfolio of the fund is diverse. They never invest in a single security.
- Mutual funds – both are mutual funds which means that many investors participate and the fund “pools” their money.
- Structure and function- there are quite a few differences and the first one is the way they actually “communicate” with investors. Open-end funds sell and buy shares directly from its investors, unlike close-end funds which function more like exchange-traded funds than a mutual fund. Closed-end funds function like exchanges and need brokerage accounts, while open-end do it directly.
- Number of shares – close-end funds have a limited number of shares which the funds offer through an initial public offering. On the contrary, open-end funds have an unlimited number of shares and investors can buy or sell them anytime.
- Price – the process of pricing is also quite different. Based on their net asset value, open-end funds set their price on a daily basis. During a specific day, there is only one price and it cannot change. On the other hand, close-end funds change their price during the day, the way stocks are traded on exchanges. These funds depend primarily on the two key market factors: supply and demand. Therefore, it’s common for close-end funds to sell their assets at a higher or much lower price than their net asset value.
My final words are the usual ones – before you dive into the world of trading and investments, you should be aware of your goals and strategy. Whether open-end funds are a good investment for you, it’s your responsibility to determine. By reading this article, you can be one step closer to making the right decision.