Mutual Fund Basics
On the surface, open-end and closed-end mutual funds may look similar. Both offer investors a low-cost way to pool their money so they can purchase shares in a diversified portfolio of stocks and/or bonds that is professionally managed and meets a particular objective. But a closer look reveals quite a few differences between these two types of mutual funds — mostly in the way they are structured and sold to investors.
The most common type of mutual funds, including those offered by American Funds, are known as open-end funds (while our funds are actively managed, open-end funds also include passive index funds). Open-end mutual funds typically do not limit the number of shares they can offer, and are bought and sold on demand. When an investor purchases shares in an open-end fund, the fund issues those shares and when someone sells shares, they are bought back by the fund. When shares are sold (known as a redemption), the fund pays the investor using cash on hand or it may have to sell some of its investments in order to pay the investor.
Open-end mutual funds are also priced differently from closed-end mutual funds, which trade on a market similar to a stock. Shares of open-end funds are bought and sold directly from the fund at a price per share that is based on the value of the fund’s underlying securities. On each trading day, typically at the end of the day, the net asset value (NAV) is calculated by dividing the market value of the fund’s assets (less expenses) by the number of shares held by investors.
Since closed-end mutual funds are traded among investors on an exchange, they have a fixed number of shares. Like stocks, closed-end funds are launched through an initial public offering (IPO) in order to raise money before they can trade in the open market. Although their value is also based on the fund’s NAV, the actual price of the fund is determined by supply and demand, so it can trade at prices above or below the value of its holdings. Closed-end funds are often actively managed unlike exchange-traded funds, which track an index and generally do not trade at a discount or premium to their NAV.
End of day
Active or passive
Both types of mutual funds have been around for quite a while. Closed-end funds are the oldest, having been introduced in the late 19th century; open-end funds followed in the early 20th century. American Funds’ oldest offering, The Investment Company of America® (ICA), was established in 1926 as an investment trust, which is similar to a closed-end fund. In 1933, ICA became a publicly owned closed-end fund and began operations under management by Capital Group a year later. By the end of the decade, ICA became an open-end mutual fund.
Today, open-end funds are by far the most popular among individual investors, who often have exposure to them through a 401(k) or other company-sponsored retirement plan. An open-end fund allows investors to participate in the markets and have a great deal of flexibility regarding how and when they purchase shares. Closed-end mutual funds may be more volatile; investors usually need to buy or sell them through a broker and are bound by the market price. But don’t confuse a closed-end fund with a “closed fund,” which is an open-end fund that no longer accepts new investors.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.