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Closed End Mutual Funds: Don't Get Confused

Author: JohnCaldwell Total views: 8 Word Count: 355

Unlike a traditional mutual funds, closed end mutual funds have little in common to the traditional open end fund. In fact, they defer significantly. As an investor r, you should learn the differences prior to investing in such funds so as to make an informed investment decision.

Characteristics

A closed end fund raises capital by issuing a limited amount of shares to the public. It does this through an initial public offering or IPO. Once it has raised the capital required, the stock begins trading in the stock market.

In a traditional fund, shares can be redeemed and issued on demand, as long as the stock market is open. This is not the case in a closed end fund, share are purchased and sold much like a regular share.

A closed end fund operates more like a company where the share of the fund are openly traded in the stock market. This is not the case in the traditional mutual fund.

In an open-ended fund, the asset of the fund grows or shrink based on the inflow or outflow of money. This is not the case in a closed end mutual funds. That is, the fund grows or shrinks based on the demand for the fund.

The share price in the traditional fund is determined by the asset value the fund holds. The share price of the closed end fund is determined based on investor demand and not the asset value the fund holds.

Caution

We recommend the novice investor stay away from closed end mutual funds, simply because the mechanics of such funds are much more complex than the traditional mutual fund. More important, although the fund is diversified as in the traditional open fund, investor demands greatly affect the value of this fund. That is, such funds are subject to the same risks that shares face in any stock market.

Specifically, most of these funds are selling at a discount in the stock market. As a result, investors who buy closed end mutual funds are trying to capitalize the gap shrinking between the discounted price and the net asset value. This can only mean investors are speculating, and speculation is risky.

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About the Author

Before you invest in mutual funds, make sure you check John Caldwell's excellent free articles on explanation of mutual funds.

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