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Closed End Mutual Funds: Don't Confuse Them

Mar 20, 2008
Unlike a traditional mutual funds, closed end mutual funds have little in common to the traditional open end fund. In fact, they defer significantly. As an investor r, you should learn the differences prior to investing in such funds so as to make an informed investment decision.

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 a 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.

A closed end fund operates more like a company where the share of the fund are openly traded in the stock market. This is not the case in the traditional mutual fund.

The value or price of the closed end fund grows or shrinks as demand for the fund increases or decrease . On the other hand, an open ended fund grows or shrinks based on the inflow or outflow of money.

In the traditional fund the price of the share is determined based on the net asset value held in the fund. The share price of the closed end fund is determined based on the demand investors place in the stock market.

Be Cautious

The novice investor should limit their investment in closed end mutual funds until they fully understand the mechanics of these funds. That is, these funds are far more complex than the traditional mutual funds. More over, the closed end fund bares more risk because it is traded in the open market where speculation has an affect on the price of the share.

Most of these funds are trading at a discount in the stock market. As a result, investors who purchase these funds are trying to make a profit by speculating the gap between the discounted price and net asset value will shrink. Once speculation enters the picture, you increase the risk of the investment.
About the Author
Before you invest in mutual funds, make sure you check John Caldwell's excellent free articles on explanation of mutual funds .
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