Open-End vs. Closed-End Funds

Open-end funds allow investors to buy and sell shares at any time based on the current net asset value (NAV), while closed-end funds have a fixed number of shares and are traded on stock exchanges like regular stocks.

When building a diversified investment portfolio, should you invest in open-end or closed-end funds? While the answer depends on your investment goals, portfolio mix and timeline, both can offer key advantages. Open-end vs. closed-end funds have a lot of similarities, along with a few major differences that investors should be aware of for long-term planning. Read on to avoid having funds tied up where you can't access them.

What Are Open-End Funds?

Open-end funds usually take the form of mutual funds. With these funds, you get a lot of flexibility. The fund creates new shares whenever someone makes a purchase and removes the shares when someone makes a sale. With unlimited shares, the funds also have daily pricing calculated as the net asset value (NAV) at the close of each trading day. 

You can buy or sell an open-end fund at the end of each trading day. That means if you place an order after the trading day has closed or on a weekend, you'll get the price of the NAV on the next trading day.

While most open-end funds are mutual funds, hedge funds and exchange-traded funds (ETFs) are sometimes structured as open-end funds. Unlike mutual funds, ETFs are traded throughout the day, similar to stocks. 

Popular open-end funds include: 

• Schwab S&P 500 Index Fund (MUTF: SWPPX)
• ​​The Hartford Core Equity Fund (MUTF: HGIYX) 
• Schwab U.S. Large-Cap Growth Index Fund (MUTF: SWLGX)
• Vanguard Mid-Cap Value Index Fund (MUTF: VMVAX)
• USAA Nasdaq-100 Index Fund (MUTF: USNQX)
• Vanguard Long-Term Investment-Grade Fund Investor Shares (MUTF: VWESX)

What Are Closed-End Funds?

Closed-end funds have a fixed number of shares and are traded on an exchange like stocks. Like stocks, the market price is determined according to supply and demand, but closed-end funds may trade at a discount or premium to their NAV. 

Factors within the fund influence whether a closed-end fund trades at a premium or discount. For example, large unrealized capital gains may cause the fund to trade at a discount due to potential tax liability. On the other hand, a fund manager with a track record of outperforming the market might cause the fund to trade at a premium.  

Closed-end funds are usually bond funds. ICI reports that as of 2023, 60% of closed-end fund assets were bonds, with the remaining 40% being equity. While bonds are usually considered low-risk investments, nearly 70% of closed-end funds use leverage to produce bigger gains. This factor presents additional risk to investors, as borrowed money can create big losses or gains.

Notable closed-end funds to consider this year include: 

• Nuveen Real Estate Income Fund (NYSE: JRS)
• ClearBridge MLP and Midstream Fund (NYSE: CEM)
• Ecofin Sustainable and Social Impact Fund (NYSE: TEAF)
• Cohen & Steers Infrastructure Fund (NYSE: UTF)
• Eaton Vance Floating-Rate Income Trust (NYSE: EFT)
• ​​Guggenheim Taxable Municipal Bond & Investment Grade Debt Trust (NYSE: GBAB)

Comparing Open-End Funds vs. Closed-End Funds

While both open-end and closed-end funds are diversified investment vehicles for long-term growth, they differ in shares, trading and popularity. Expense ratios and fees are another factor to watch out for. Wondering how open-end vs. closed-end funds stack up in operations and investment opportunities? Find the key differences below. 

Fund Structure and Operations

The differences in fund structure and operations can significantly impact the liquidity and volatility of funds. While closed-end funds offer what would appear to be more trading opportunities, they are generally less liquid, and by extension less popular, than open-end funds. 

Open-End Funds

Open-end funds are structured and managed by investment companies. They continuously offer new shares and take shares out of circulation. Because of the pooled assets of open-ended funds,  investors can make ongoing new contributions and withdrawals from the pool. You don't usually need a lot of money to invest in an open-end fund, making these funds accessible for all levels of investors.

Open-end funds offer portfolio diversification for a specific purpose. As in the examples above, open-end funds may track major indexes, like the S&P 500, or focus on another stated investment objective, such as targeting investments in specific industries or countries. They may be actively or passively managed, based on the fund's objectives.

Closed-End Funds

Closed-end funds launch through an initial public offering (IPO) and trade like stocks on the market. Closed-end funds are considered less liquid than open-end funds. The shares are bought and sold on a public stock exchange, but no new shares are created. Closed-end funds are actively managed and may focus on a specific industry, sector or region.

While open-end funds trade at NAV, a closed-end fund may trade at a discount or premium from its NAV. The fund manager and their track record can play a major role in whether a closed-end fund is sold at a discount or premium. Shares in closed-end funds must be traded through a broker. 

A sub-type of a closed-end fund is an interval fund, which is not listed on an exchange. Instead, an interval fund periodically offers to repurchase a limited percentage of outstanding shares from its shareholders. Interval funds may offer higher yields but have lower liquidity and higher fees. 

Differences in Investment Strategies

Investment strategies between closed-end and open-end funds also show key differences, especially in liquidity and expense ratios, which can have a major impact on long-term portfolio performance. Here's what to watch out for.  

Open-End Funds

Open-end funds are diversified funds that may employ specific investment strategies. Index funds are not actively managed, but most other open-end funds are actively managed. Some open-end funds target specific sectors, asset classes or regions, such as oil and gas, real estate, technology, sustainable technologies or AI. 

Open-end funds offer built-in diversification to reduce risk. In the case of actively managed funds, the fund manager's track record and the target industry or sector could lead to substantial growth. In the case of index funds, the long-term track record of the markets offers strong historical returns with low expenses. 

Closed-End Funds

Many closed-end funds focus investment strategies around bonds. In fact, some of the largest type of closed-end funds, measured by assets under management, are municipal bond funds.

Managers of closed-end funds usually seek broad diversification to reduce risk. However, many closed-end fund managers rely heavily on leverage to maximize returns, presenting additional risk to investors. The potential advantages of closed-end funds' strategies are significant growth, while the greatest disadvantage is leverage and the potential for significant loss it presents. 

While both open-end and closed-end funds may focus on specific industries or sectors, closed-end funds are traded throughout the day, while open-end funds are only traded at the end of the trading day. 

Investor Considerations

As an investor, liquidity, fees and expense ratios of open-end vs. closed-end funds are critical to long-term portfolio growth. Here's how open-end vs. closed-end funds stack up.  

Liquidity

According to the Investment Company Institute, closed-end funds are less liquid than open-end funds because they don't need to maintain cash reserves or sell securities to meet redemptions. For that reason and because closed-end funds tend to be more volatile open-end funds are generally more popular with investors. 

To assess the liquidity of investment funds, look at the bid-ask spread. This is the difference between the highest price a buyer is willing to purchase the stock (bid), and the lowest price the seller is willing to sell it (ask). The tighter the spread, the smaller the difference and the greater the liquidity. A fund with a large bid-ask spread is considered significantly more illiquid. 

Expense Ratios and Fees

Expense ratios and associated costs in any investment are a major consideration as they can reduce potential returns. Generally, the expense ratio for closed-end funds tends to be lower than that for comparable open-ended funds. 

Likewise, actively managed open-end funds may charge high fees and expenses. However, for many investors, the performance of these actively managed funds compensates for the higher fees. 

When choosing investment vehicles, you want to minimize fees and expenses to maximize growth. Look for funds with low stated expense ratios and fees. A 1% annual fee can reduce a portfolio by nearly $30,000 over 20 years, compared to a portfolio with an annual fee of 0.25%. Generally, both open- and closed-end funds have low fees, but investors should double-check any fund's total fees. 

Open-end vs. Closed-end Funds: Which is Better?

Both closed-end and open-end funds offer long-term growth opportunities. However, open-end funds are more popular with investors because of the lower risk and greater liquidity. However, a diversified portfolio across asset classes and sectors offers essential risk mitigation. 

Both open-end and closed-end funds can have a place in your portfolio. Check expense ratios, total fees, liquidity and manager track record and remember to diversify. To get started, find the best mutual funds or the best bond funds this year.

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