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What's the Difference Between Open- and Closed-End Mutual Funds?
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When investing in mutual funds, investors can choose between open- and closed-end funds. Understanding how each works can help you make the right decision.

Open-End Funds

You invest your money in an open-end mutual fund by buying shares at the net asset value (NAV). Net asset value is the market value of the fund's assets at the end of each trading day minus any liabilities divided by the number of outstanding shares.

Open-end funds determine the market value of their assets at the end of each trading day. For example, a balanced fund, which invests in both common stocks and bonds, uses the closing prices of the stock and bond holdings for the day to determine market value. The total number of shares of each of the stocks and bonds that the fund owns is multiplied by the closing prices. The resulting total of each investment is added together, and any liabilities associated with the fund (such as accrued expenses) are subtracted. The resulting total net assets are divided by the number of shares outstanding in the fund to equal the net asset value price per share.

The NAV changes daily because of market fluctuations of the stock and bond prices in the fund. NAVs are important because:


  1. The NAV is used to determine the value of your holdings in the mutual fund (the number of shares held multiplied by the NAV price per share).
  2. The NAV is the price at which new shares are purchased or redeemed.

NAVs of the different funds are quoted in daily newspapers or on the funds' Web sites.

Mutual funds pay no taxes on income derived from their investments. Under the Internal Revenue Service Tax Code, mutual funds serve as conduits through which income from investments is passed to shareholders in the form of interest or dividends and capital gains or losses. Individual investors pay taxes on income and capital gains distributions from mutual funds.

Shareholders receive monthly and annual statements showing purchases and sales of shares, interest income, dividends, capital gains and losses, and other relevant data that they should retain for tax purposes. In addition, when investing in mutual funds, investors also should keep track of the NAV prices of shares purchased and sold. This information is used in the computation of gains and losses when shares are redeemed.

The value of a mutual fund increases when:


  • Interest and dividends earned on the fund's investments are passed through to shareholders.
  • The fund's management sells investment securities at a profit. The capital gains from such a sale are passed through to shareholders. If these securities are sold at a loss, the capital loss is offset against the gains of the fund, and the net gain or loss is passed through to shareholders.
  • The NAV per share increases.

Closed-End Funds

Closed-end funds issue a fixed number of shares that are traded on the stock exchanges or in the over-the-counter (OTC) market. When the shares are sold, the fund does not issue more shares. Like open-end funds, these funds have professional managers who assemble and manage the investment portfolios according to the goals and objectives of the funds. Unlike open-end funds, however, closed-end funds do not trade at their NAVs. Instead, their share prices are based on the supply of and demand for their funds and other fundamental factors. Consequently, closed-end funds can trade at premiums or discounts to their NAVs. Closed-end fund prices can be obtained from financial newspapers or from Web sites on the Internet.

Shares of closed-end funds are bought and sold through brokers.

You should be aware of the following facts about the purchase of closed-end funds:


  • Brokerage firms underwrite and sell newly issued shares of closed-end funds.
  • The brokerage fees on these newly issued shares can be quite high, which then erodes the price of the shares when they trade on the market. For example, if a closed-end fund sells 1 million shares at $10 per share and there is a brokerage commission of 7%, the fund receives $9.3 million to invest ($700,000 is deducted from the $10 million proceeds). The share price drops in value from the $10 originally paid and trades at a discount to the offer price.
  • Also consider that in the case of a newly issued closed-end fund, the portfolio of investments has not yet been constituted, so investors do not know what the investment assets are and, in the case of bond funds, the yields on those investments.
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Excerpted from All About Investing by Esme Faerber. Copyright © 2006 by The McGraw-Hill Companies.

© Wealth Management Systems Inc. All rights reserved.

This material is authored by Wealth Management Systems Inc. and was not authored by Merrill Edge. Assumptions, opinions and estimates constitute judgment from Wealth Management Systems Inc. as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue.

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