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Closed-End Fund (CEF) vs. Open-End Fund

Instructor: Ian Lord

Ian is a real estate investor, MBA, former health professions educator, and Air Force veteran.

In this lesson, we will look at the differences between closed-end funds and open-end funds, with special attention given to how these funds are bought and sold as well as priced.

Closed-End and Open-End Funds

Bob is an investor who wants his portfolio to benefit from diversification but doesn't have the time or energy to manage his own investments. Rather than try constantly to pick which stocks he should buy and sell, he just wants to buy one or two investments that take care of all that for him. His options include investing in closed-end or open-end funds. Let's help Bob understand what these funds are and how they compare so he can make a decision about his investments.

Definitions

To Bob's surprise, he is already familiar with open-end funds. An open-end fund refers to a regular mutual fund. When Bob sends his money, to the fund he receives new shares in the fund. Those funds are then used by the fund manager to buy stocks, bonds, or other investments according to the prospectus or plan for the fund. For example, the prospectus might say the fund only invests in US-based companies or focuses on a segment such as real estate or healthcare.

When Bob wants to cash out, those shares are returned to the fund company and taken out of circulation. If enough shares are sold, the mutual fund company will have to sell some of the underlying investments to get Bob his money. Buying and selling of open-fund shares are transactions between the investor and the mutual fund company

A closed-end fund combines elements of a mutual fund and stock. An investment company creates shares through an initial public offering (IPO). Once these shares are created, they are traded from investor to investor over an exchange on the open market like a stock. Unlike a mutual fund, shares are not destroyed when an investor sells. Only a limited number of shares are in existence. Management of the fund remains much the same as a mutual fund; a fund company manager using the investors' money buys and sells different kinds of investments according to the prospectus.

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