Mutual funds offer novice and experienced investors alike an opportunity to participate in stock and bond markets, by pooling their resources with other investors and trusting an experienced fund manager with their money. Open-end and closed-end mutual funds share a number of characteristics, but they differ greatly in the way they are bought and sold, as well as in their restrictions for membership. Both types of mutual funds carry their own advantages, and each is best suited to different investors and situations.
When most people think of traditional mutual funds, they are thinking of open-end funds. Open-end mutual funds may be sold in as many shares as desired, allowing them to expand indefinitely. These funds grow by adding new clients to the pool, increasing the amount of money with which to invest over time. Shareholders benefit from this structure by realizing a steadily increasing yield, assuming the fund performs as expected, and they receive their profits in their personal fund accounts.
Unlike open-end funds, shares of closed-end funds are traded on the NASDAQ, the electronic stock exchange in the United States. Closed-end funds sell a limited number of shares once, and they cannot issue new shares at will in the future. Shareholders make their profit by buying and selling existing shares on the exchange. Market valuations for these funds vary according to the same forces that act upon stock prices, including investor expectations and technical performance metrics.
Closed-end funds can have a longer time horizon than their open-ended counterparts, causing them to be less susceptible to negative impact from short-term downturns. Closed-end funds can also trade at a higher price than their net asset value--the metric used to determine the price of open-end fund shares--boosting profit potential.
While market-based pricing can afford greater profit opportunities at times, the pricing of open-end funds is generally more reliable. Since open-end funds are priced based on their net asset value, prices more accurately reflect actual fund performance, taking subjective issues like investor confidence out of the equation. Open-end funds can offer better opportunities for early investors as well; open-end funds generally rise in value after their introduction, while closed-end funds generally fall in value immediately after introduction.
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