Closed End Mutual Funds: Don't Get Confused

By: John Caldwell

Closed end mutual funds have little in common to the traditional open end fund, better known as mutual funds. In fact, they vary quite significantly. As a novice investor, you should learn the differences prior to investing in such funds so as to reduce your risk of losses.

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.

The traditional fund issues and redeems shares on demand, thus meaning there is no limit. On the other hand, a closed end fund issues a limited amount of shares.

The shares of a closed end fund trades in the stock market based on the supply and demand of the shares. In a traditional fund, the shares are purchased directly from the mutual fund company.

The value in a closed end fund grows or shrinks based on the demand for the fund. In an open ended fund, the asset of the fund grows or shrink based on the inflow or outflow of money.

The share price of the closed end fund is determined based on investor demand and not the asset value the fund holds. The share price in the traditional fund is determined by 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 sell at a discount in the stock market. This being the case investors who buy closed end mutual funds are banking that the gap between the discounted price and the net asset value will shrink, thus making a profit. This means they are speculating, and speculation is risky.

Article Source: http://www.bigfreearticles.com

About the Author:
Before you invest in mutual funds, make sure you check John Caldwell's excellent free articles on advantages of mutual funds.

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