Table of Contents
- What Is an Open-End Fund?
- Key Takeaways
- How an Open-End Fund Works
- Open-End Funds vs. Closed-End Funds
- Pros and Cons of Open-End Funds
- Example of an Open-End Fund
- Can You Sell Back Shares of an Open-End Fund?
- Are Open-End Funds Regulated?
- Do Open-End Funds Pay Dividends?
- What Impact Do Investor Redemptions Have on an Open-End Fund?
- The Bottom Line
What Is an Open-End Fund?
Let me explain what an open-end fund is: it's an investment vehicle that creates and redeems shares based on investor demand, pooling your money into a diversified portfolio without a fixed share limit.
You can contribute money into this shared, professionally managed portfolio of securities, and the fund creates new shares as needed to match that demand. The fund sponsor sells shares directly to you and redeems them too. These shares get priced daily based on their net asset value (NAV). Most mutual funds and exchange-traded funds (ETFs) fall into this category.
They're more common than closed-end funds and make up the bulk of investments in 401(k) plans.
Key Takeaways
An open-end fund uses pooled assets, allowing ongoing new contributions and withdrawals from investors like you. This means it has a theoretically unlimited number of potential shares outstanding. Most mutual funds and ETFs are open-end funds. Open-end mutual fund shares don't trade on exchanges and are priced at their portfolio's NAV at the end of each day, while ETFs trade throughout the trading day.
How an Open-End Fund Works
An open-end fund issues shares whenever buyers like you want them—it's always open to investment. When you purchase shares, the fund creates new ones to replace them, and selling shares takes them out of circulation.
You buy and sell shares on demand at their NAV, which is calculated daily based on the value of the fund’s underlying securities at the end of the trading day for mutual funds. If a lot of shares get redeemed, the fund might sell some investments to pay you and other selling investors.
This setup gives you an easy, low-cost way to pool money and buy a diversified portfolio. These funds target goals like growth, income, large-cap, or small-cap stocks, and can focus on specific industries or countries. You typically don't need much money to get started.
Sometimes, if the fund's management thinks its assets have grown too large for its goals, they close it to new investors. In rare cases, investors push to turn it into a closed-end fund.
Open-end funds are so common that they're basically synonymous with mutual funds, and you might not realize there are other types. Most mutual funds and ETFs are open-end, though pooled investments were mostly closed-end until the 1970s.
Open-End Funds vs. Closed-End Funds
Closed-end funds launch through an initial public offering and trade shares on exchanges. Their prices can be at a discount or premium to the NAV based on supply and demand during the trading day.
They can cost more due to wider bid-ask spreads for illiquid funds, and their prices might be volatile, higher or lower than the NAV suggests. You have to trade closed-end fund shares through a broker.
Pros and Cons of Open-End Funds
Both open- and closed-end funds are managed by portfolio managers with analysts' help. They reduce security-specific risk through diversified investments and have lower costs from pooling investor funds.
Open-end funds must keep ample cash reserves for redemptions, which aren't invested and can lower yields. They typically provide more security, while closed-end funds might offer bigger returns.
Management has to adjust holdings continually to meet demand, so fees can be higher. But you get greater flexibility in buying and selling since the fund always makes a market in them.
Pros
- Hold diversified portfolios, lessening risk
- Offer professional money management
- Are highly liquid
- Require low investment minimums
Cons
- Must maintain high cash reserves
- Charge high fees and expenses (if actively managed)
- Post lower yields (than closed-end funds)
Example of an Open-End Fund
Take Fidelity's Magellan Fund, founded in 1963—it became legendary in the late 1970s and 1980s for beating the stock market regularly. Its manager from 1977 to 1990, Peter Lynch, became a household name.
It got so popular that in 1997, it closed to new investors because managing its large asset base was tough. The fund peaked around $100 billion in the late 1990s/early 2000s and reopened in 2008.
Can You Sell Back Shares of an Open-End Fund?
Yes, you can generally sell your shares back to the fund at any time based on the current NAV.
Are Open-End Funds Regulated?
Yes, they face regulatory oversight to protect investors, usually from bodies like the U.S. Securities and Exchange Commission.
Do Open-End Funds Pay Dividends?
Yes, they may pay dividends from investment income, which you can reinvest or receive directly.
What Impact Do Investor Redemptions Have on an Open-End Fund?
Redemptions can force the fund to sell assets to meet demands, affecting its composition and performance.
The Bottom Line
Open-end funds are a popular choice if you're seeking diversification and flexibility—they allow unlimited shares priced relative to NAV. For mutual funds, NAV is calculated at the close of trading each day. They offer advantages like liquidity and various options, but watch for management fees and redemption impacts on performance.
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