A mutual fund is a type of investment characterized by the pooling of funds from several investors in order to have greater returns on securities investments such as stocks, bonds and money markets. This allows small investors to take advantage of large, diversified portfolios. Professional money managers take care of the actual investing for the mutual fund. Mutual funds can be described as open or closed, with open mutual funds being far more common.
Basic Differences Between Open and Closed Mutual Funds
If a mutual fund is open, an investor can buy shares at any time. The total assets of the mutual fund can change daily as investors purchase or redeem their shares. The number of available shares is unlimited. Open mutual funds are generally sold directly to shareholders and are not traded on the stock market. In a closed mutual fund, there are a fixed number of shares that are only sold once. Closed mutual funds are traded on the stock market. Demand for shares determines the price of a closed mutual fund, rather than the net asset value (NAV).
Advantages of Open Mutual Funds
An open mutual fund allows a shareholder to sell their shares quickly because other people are purchasing shares on a daily basis. Usually, an open mutual fund will allow you to transfer your funds within a family of various other funds without a fee. Open mutual funds tend to be well diversified so that if one stock or other security in the portfolio goes down, it has less impact than if you only invested in one or two stocks.
Disadvantages of Open Mutual Funds
If an open mutual fund is focused on one industry or sector, a fluctuation in market conditions can more seriously affect investor's returns. One risk of open mutual funds is that if a large number of people are buying or selling shares at one time, the mutual fund will see a sudden temporary rise or fall in the price.
Advantages of Closed Mutual Funds
The major advantage of a closed mutual fund is that investors can often buy shares at a price below net asset value while still having a professionally managed mutual fund. The difference between this discount and the value when the mutual fund sells results in increased returns. Experienced investors can find these mutual funds on the open market similar to stocks.
Disadvantages of Closed Mutual Funds
A closed mutual fund often requires a larger minimum investment and a longer term commitment. Because the value of a closed mutual fund is subject to change rapidly, these mutual funds are more appropriate for those investors with experience because it can be difficult to recognize the true value of any given portfolio when it is sold at a discount. Closed mutual funds can't be sold at any given time, so it is important to find a fund that is most likely to increase in value given the current stock market.
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