There are hundreds of mutual fund schemes available to investors. To help them make informed decisions, these schemes are classified based on the risk profile of the scheme, investment philosophy, etc. Based on the structure, a mutual fund can be differentiated as an open-ended fund or a closed-ended fund. The core difference is the ease and flexibility of purchasing and redeeming units. In this article, we will talk about the difference between Open-Ended and Closed-Ended funds.

Before we begin, let’s understand these two types of funds. 

Open Ended Funds

Open Ended funds are the most common type of mutual fund schemes available to investors. In fact, when most people talk about mutual funds, they unknowingly refer to open-ended schemes. The fund houses of these schemes offer units and purchase them from investors on all working days.

This allows investors to enter and exit the scheme whenever they want. Hence, they are called Open Ended schemes. The units are bought and sold at the Net Asset Value (NAV) which is calculated by dividing the total assets of the scheme by the number of outstanding units.

Open Ended funds offer certain advantages and disadvantages:

Advantages 

Here are some important advantages of open-ended schemes:

Liquidity – Investors can buy and sell units on any working day at the prevalent NAV

SIP investment – Open Ended schemes allow investors to invest via a Systematic Investment Plan (SIP) making it a good option for the salaried class of people.

Performance assessment – Being open-ended, the scheme provides information about the performance of the scheme across various market cycles. This can help you make an informed decision.

Disadvantages – Here are some disadvantages of closed-ended schemes:

Market Risks – The NAV of the scheme fluctuates based on the performance of the underlying benchmark. Hence, investing in open-ended schemes is subject to market risks.

Closed Ended Funds

In contrast to the open-ended schemes, a closed-ended scheme offers a fixed number of units to investors during the NFO (New Fund Offer). These schemes have a fixed maturity period. Once the NFO period is over, investors cannot buy the units of the scheme from the fund house. However, the units of a closed-ended scheme are listed on a stock exchange to ensure liquidity. The fund value is based on the NAV but the units are not traded at the NAV. Being traded on the stock exchange, the price of a unit is proportionate to its demand and supply. Hence, you can buy the units of a closed-ended scheme at a discount or a premium to its NAV. 

Closed Ended funds offer certain advantages and disadvantages:

Advantages – Here are some important advantages of closed-ended schemes:

Fund House can plan its investments without worrying about purchase and redemptions – Since investors can buy or sell units from the fund house only on the maturity of the fund, the fund manager can create an investment strategy without thinking about the asset base growing or shrinking. This allows the fund manager to create a more holistic investment plan.

Opportunity for Investors – Units of a closed-ended scheme are traded on the market at market prices determined by their demand and supply. This provides an opportunity for investors to use strategies similar to stock trading and earn good returns.

Disadvantages – Here are some disadvantages of closed-ended schemes:

Non-availability of SIP – Since you need to buy the units of a closed-ended scheme at the time of the NFO, you need to make a lumpsum investment. This is not preferred by many investors who want to stagger their investments using the SIP approach. Also, a lumpsum investment exposes you to bigger risks.

Performance assessment – In a closed-ended scheme, since the fund house does not permit purchase and redemption of units before the maturity period, the track record of the performance of the fund during various market cycles is not available. Hence, you cannot assess the performance of the scheme and have to depend on the judgment of the fund manager.

Which is better: Open-Ended or Closed Ended Mutual Funds?

To answer this question, let’s take an overview of the difference between Open-Ended and Closed-Ended Mutual Funds:

Factors OPEN-ENDED FUNDS CLOSED-ENDED FUNDS
When can I subscribe to the units? On any working day, throughout the year Only during the NFO period
Does the scheme have a maturity period? No Yes
Who offers liquidity of the units? Fund House Stock market
Can I trade the units on a stock exchange? No Yes
How are the transactions executed? At the end of the day In real-time
At what price are the units bought and sold? At the NAV At market prices determined by the demand and supply of the units

Summing Up

Looking at both the sides of the coin, we recommend that you must include mutual funds in your investment portfolio. However, before you sign the dotted line, ensure that you create an investment plan based on your financial goals, risk preference, and investment horizon and choose your investment vehicles wisely. You work hard for the money you ear. Ensure that you give your money a good chance to work equally hard for you.

Disclaimer: The views expressed in this post are that of the author and not those of Groww