Mutual funds offer investors the opportunity to invest in a diversified portfolio of securities managed by professionals. They are broadly categorized into two types: open-ended and close-ended funds. Understanding the differences between these two types can help investors make informed decisions based on their financial goals and risk tolerance.
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Open-Ended vs. Close-Ended Funds
Open-ended funds are a type of mutual fund that do not have restrictions on the transfer of shares. These funds are available for subscription and redemption throughout the year, providing investors with high liquidity. The Net Asset Value (NAV) of open-ended funds is calculated at the end of each trading day based on the value of the fund’s underlying securities. While most open-ended funds do not have a fixed maturity date, Equity Linked Savings Schemes (ELSS) have a lock-in period of 3 years. Unlike close-ended funds, open-ended funds are not traded on the stock exchange.
“Close-ended funds issue a fixed number of units during the New Fund Offer (NFO) period, after which no new units can be purchased. These funds have a specified maturity date and a lock-in period, during which investors cannot redeem their investment. Once the fund is listed on the stock exchange, investors can trade the units, but the volume of trading in close-ended funds is generally low. Close-ended funds may offer a lower expense ratio compared to open-ended funds,” says Rishabh Goel, MD, Tailwind Financial Services.
Key Differences
Liquidity: Open-ended funds offer high liquidity, allowing investors to redeem their investment at any time. Close-ended funds have limited liquidity, as redemptions are allowed only after the maturity date.
Investment Options: Open-ended funds offer the option of Systematic Investment Plans (SIPs), allowing investors to invest a fixed amount regularly. Close-ended funds require investors to invest a lump sum amount during the NFO period.
Trading: Open-ended funds are not traded on the stock exchange, while close-ended funds are traded on the exchange after the NFO period.
Expense Ratio: Close-ended funds generally have a lower expense ratio compared to open-ended funds.
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Past Performance: Close-ended funds do not have a track record of past performance at the time of NFO, while open-ended funds have a performance history that investors can consider.
Pros and Cons
Open-ended funds offer higher liquidity and the flexibility to invest through SIPs. Close-ended funds have lower expense ratios and can prevent investors from making impulsive decisions in volatile markets.
However, close-ended funds lack liquidity and do not offer SIP options. They also require investors to invest a lump sum amount during the NFO period.
Rationale for Choosing Open or Close-Ended Funds
“The choice between open and close-ended funds depends on the investor’s needs and objectives. Close-ended funds may offer more stability for long-term investors, while open-ended funds provide liquidity and flexibility,” informs Goel.
Taxation
Both open and close-ended funds are treated similarly for tax purposes. Short-term capital gains (holding period less than 1 year) are taxed at 15%, and long-term capital gains (holding period more than 1 year) are taxed at 10% for equity-oriented funds.
Conclusion
Mutual funds are an effective way to invest in the financial markets, and understanding the differences between open-ended and close-ended funds can help investors make informed decisions.
“While open-ended funds offer liquidity and flexibility, close-ended funds may be suitable for investors with specific investment goals and a longer investment horizon. By evaluating their investment objectives and risk tolerance, investors can choose the right type of mutual fund to meet their financial needs,” says Goel.
