Closed-End Funds versus Open-End Funds

The most popular kind of mutual fund is known as an openend fund. (In fact, unless it’s otherwise stated, you can assume that any mutual fund you hear or read about is an open-end fund.) An open-end fund continuously issues new shares and redeems old shares on demand.
When such a fund is popular, money flows in to the fund manager from investors who are eager to own shares. The manager then invests this new money in additional stocks and/or bonds. New shares in the fund are constantly being created.
By contrast, closed-end funds issue a fixed number of shares. After investors buy these shares, no more money can enter the fund. If you want to sell shares that you own, you don’t sell them to the fund management firm, as with an open-end fund. Instead, the shares trade on an exchange, much like the trading of shares in the stock of individual companies. Thus, the price of a share in a closed-end fund is set by supply and demand: If investors are eager to buy the shares, the price rises; if not, the price falls.
Like an open-end fund, a closed-end fund has a net asset value, computed by dividing the total value of the fund’s portfolio holdings by the number of shares. However, the shares of an open-end fund may sell at a premium to the NAV (that is, for more than the NAV) or at a discount to the NAV (that is, for less than the NAV).
For instance, if a particular closed-end fund has an NAV of, say, $15 per share, the actual price at which the shares trade may be higher (say, $18 per share) or lower (say, $11 per share).
Of course, you’re better off buying shares of a closed-end fund at a discount rather than at a premium. In fact, experts generally advise investors to buy closed-end fund shares only when they’re available at an attractive discount. A mutual fund company may decide to offer a closed-end fund rather than an open-end fund for several reasons. The main consideration: a desire to avoid having too much money to invest.
With a closed-end fund, the fund manager knows how much money he must handle; he doesn’t continually get new money to invest, as may be the case with an open-end fund. In some investment markets, closed-end may be a better way of doing business.
For example, an emerging market (that is, a new or relatively undeveloped business region, such as South America or Eastern Europe) may have only a limited number of good companies in which to invest. The manager of a fund specializing in such a market may worry about taking in more money than he can invest wisely. A closed-end fund solves this problem. For the average investor, open-end funds are a better choice than closed-end funds. Newspapers and financial magazines cover open-end funds more extensively, which makes it easier to track them. They are more liquid than close-end funds —that is, easier and more convenient to buy and sell. And their prices are less volatile; upward and downward movement is slower and more predictable.
Some sophisticated investors are especially interested in closed-end funds, but they are probably not the best starting point for the individual who is new to mutual funds.