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Closed End Mutual Funds: Don't Confuse Them

Traditional mutual funds are not the same as their counterpart, closed end mutual funds. That is, they vary quite considerably. For this reason, new investors should get acquainted with this investment vehicle prior to investing, since they bare more risk.

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.

In a traditional fund, shares can be redeemed and issued on demand, as long as the stock market is open. This is not the case in a closed end fund, share are purchased and sold much like a regular share.

The shares of a closed end fund trades in the stock market based on the supply and demand of the shares. In a traditional fund, the shares are purchased directly from the mutual fund company.

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.

The share price of the closed end fund is determined based on investor demand and not the asset value the fund holds. The share price in the traditional fund is determined by the asset value the fund holds.

Caution

The new investor should stay away from investing the closed end mutual funds until they have understood the function of these funds. The funds are complex in nature and require know how, which is not requirement with the traditional mutual funds. More Important, the closed end funds have a higher risk than the open ended funds since it is being trade in the stock market.

Specifically, most of these funds are selling at a discount in the stock market. As a result, investors who buy closed end mutual funds are trying to capitalize the gap shrinking between the discounted price and the net asset value. This can only mean investors are speculating, and speculation is risky.

Article Source: http://www.uberarticles.com/articles

Before you invest in mutual funds, make sure you check John Caldwell's excellent free articles on explanation of mutual funds. Click here for other unique closed end mutual funds articles.

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