Mutual funds are often good choices for investors because they allow people to diversify their portfolios while having the convenience of investing in one product. They place investors' funds under the control of an experienced manager. Investors who want to invest in these funds should find out more about them, including the difference between the two types of mutual funds -- open-end and closed-end.
Open-end Mutual Funds
A mutual fund is an entity that sells shares of itself to investors. Their money is combined and used to purchase a portfolio, which is controlled by the fund manager. The returns that it earns are passed to the shareholders in the form of higher share prices. If the fund is open-end, there is no maximum number of shares. When the fund sells more shares, the new money is used to expand the fund's portfolio.
Closed-end Mutual Funds
Closed-end mutual funds have the same basic structure that open-end funds have, but the number of shares of the fund is limited. The fund issues a set number of shares when it is created, and this event is known as an initial public offering. After that, if an investor wants to invest in the fund, he must find another investor who has shares of the fund and is willing to sell them.
The shares of the two types of funds are traded in different ways. Shares of open-end funds are not traded on exchanges, since investors can always buy shares from the fund itself; it takes orders to buy and sell shares throughout the day. At the close of the trading day, the fund carries out the day's orders. Shares of closed-end funds are originally sold by the fund in the initial public offering, and subsequent trades are made between investors on exchanges.
The differences in the ways in which the shares are traded mean that they are priced differently as well. Open-end funds determine the share price at the end of each day. The fund adds up the value of its assets, subtracts its liabilities, and divides that total by the number of outstanding shares. The resulting number is called the net asset value, and it is the price of each share. The value of a closed-end share, like that of stocks, varies according to the demand that the market exhibits. Each share can thus trade at a price that is below, at or above its net asset value.