by Archie M. Richards, Jr.
July 30, 2007

Kyle writes, "Would you please explain the difference between open and closed end funds."

Sure, Kyle. First, be aware that all mutual funds involve two sets of securities. The shares of stocks (or bonds) in the mutual fund's portfolio are owned by the fund. The shares of the mutual fund itself are owned by the public.

All funds calculate their net asset values (NAV) by totalling the market values of the securities they own and subtracting the liabilities. This multi-million-dollar number is divided by the number of fund shares held by the public, to find a small number reported as the net asset value.

Okay, now for the differences between open end and closed end funds:

Open End: When you buy shares of an open end fund, your money goes to the fund, and the fund creates new shares of the mutual fund are created for you in return.

When you sell shares of an open end fund, your shares go back to the fund and disappear. The fund pays cash in return. If it doesn't have the cash, it must sell some of the stocks in its portfolio.

If the public's demand for the fund grows, the number of shares of the fund increases. If the demand lessens, the number of shares declines. Because of the daily fluctuation, the fund's price always equals the net asset value.

Open end funds can be bought or sold only after the market closes each day - after the closing prices of the stocks in the underlying portfolio have been determined. Only market orders are accepted - no limit orders or short sales.

Open end funds are not listed on exchanges; the fund handles the purchases and sales itself. Funds not sold by brokers are called "no-load" funds. Funds sold by brokers are called "load" funds. Money to pay the broker is deducted from the investor's account, either immediately or on a deferred basis. The symbols of most open end funds contain 5 letters.

The fund accommodates automatic investments. At your request, it can dip into your bank account to obtain money for additional purchases. It can also use dividends and/or capital gains to purchase additional shares. The fund creates new shares to reflect these purchases.

The fund can also pay money directly to your bank account on a regular basis, causing shares of the fund to disappear in return.

Closed End: When you buy shares of a closed end fund, your money does not go to the fund. It goes the person or institution from whom you bought the shares. The fund itself creates no new shares.

When you sell shares of a closed end fund, you do so to an individual or institution, receiving cash in return. Except to record the new owner's identity, the fund has nothing to do with these transactions.

All such transactions are arranged by brokers in the secondary market. Most closed end funds are listed on the New York Stock Exchange, with symbols containing 3 letters.

The fund does not withdraw money from or pay money to your bank account. When dividends and/or capital gains are paid out, you have no choice but to receive them in cash. (Most people hold their share electronically at a brokerage firm.)

Since the number of shares of the fund is fixed, the price of the fund is seldom equal to the fund's net asset value. When the price exceeds the NAV, it is said to stand at a "premium." When the price is lower than the NAV, it stands at a "discount." Most closed end funds stand at discounts most of the time.

Closed end funds add an element of risk: Say the NAV of a closed end fund is 100. You buy shares at a 15 percent premium (115). The NAV than falls by 10 percent to 90, and the premium also turns into a 15 percent discount (76.50). You've lost one-third of your money (115 to 76.50). Try to avoid this.