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Closed-end mutual funds

Closed-end funds provide higher yields than some other investment options, but suffer from a lack of liquidity.

Closed-end mutual funds, like other mutual funds and ETFs. allow you to invest in a diversified portfolio through one investment. But they have unique benefits and drawbacks that you should know before you make a buy. Here’s a look.

Closed-end mutual funds defined

A closed-end mutual fund is an investment portfolio that raises capital one time only through an initial public offering — or IPO. As its name suggests, the fund is closed to additional capital after the IPO. No additional shares are sold, and the fund does not purchase back shares. A closed-end fund is different from a closed fund, which is an open-end fund not currently taking in new money.

Closed-end mutual fund (n): An investment portfolio that raises capital one time through an initial public offering (IPO).

Every closed-end fund has stated objectives — for example, tax-free income, fixed income or market segment — and the fund is managed according to those objectives.
Shares of a closed-end fund are traded publicly like stocks. The fund’s net asset value is one factor in its value. However, unlike an open-end fund, the current price of the fund rises and falls due to market forces.

7 key characteristics of a closed-end mutual fund

Some characteristics of closed-end funds are unique, while others are similar to exchange-traded funds and open-end mutual funds. Here are the seven key characteristics of a closed-end mutual fund:

  1. They’re publicly traded investment companies, with both the fund and its portfolio manager required to register with the U.S. Securities and Exchange Commission.
  2. Professional management teams oversee them.
  3. They charge an annual expense ratio.
  4. They may make income and capital gain distributions to shareholders.
  5. They require a brokerage account to buy and sell, unlike many open-end funds.
  6. They raise capital only once — through an IPO.
  7. Prices for closed-end funds fluctuate throughout the day.

“Because of their structure, closed-end funds can trade at significant premiums or discounts to the net asset value of their investments.” –– Matt Hylland, financial planner and partner at Arnold and Mote Wealth Management

This means that you may pay more or less than the value of your share of the funds’ underlying investments, depending on market demand for the fund.

Closed-end funds pros and cons

Although open-end and closed-end funds are both professionally managed, closed-end funds are traded like equity and have specific advantages and disadvantages.

Pros

  • Diversified portfolio
  • Professional management
  • Transparent pricing
  • Higher yields on average than open-end funds

Cons

  • Available only through brokerages, unlike funds that sell directly to investors
  • Less liquidity than open-end funds
  • May be heavily discounted
  • Higher fees than open-end funds

Closed-end vs. open-end funds vs. ETFs

Closed-end funds are similar to open-end funds in that both are professionally managed and can be solid investment choices. And both of these are similar to exchange-traded funds (ETFs) — but they all have several differences.

Closed-end fundOpen-end fundETFs
Trades only through a brokerMay be purchased directly from the fundMay be purchased through any broker or brokerage app
Prices fluctuate due to market forcesPrices based on net asset value at end of dayPrices based on net asset value, with minor market price differences
Raises capital only onceMay sell more shares to raise capitalShares issued and bought back anytime
Higher yieldsLower yields than closed-end fundsLower yields than closed-end funds
Higher fees than open-end fundsLower fees on averageLower expense ratios, more cost-effective

“Closed-end funds typically have much higher fees for their investors — in the form of interest expense and the fund’s expense ratio — than open-ended funds,” explains Hylland. The funds’ heavily managed portfolios and active trading strategies come with a price. “That can lead to expenses of 1% or more each year,” he adds. “Over time, these fees can hurt an investor’s return and lead to underperformance compared to lower-cost alternatives like open-ended funds.”

How to invest in closed-end funds

Buying closed-end mutual funds as a retail investor is as easy as purchasing stock or any other securities. Simply open an account with an online investment broker. If you need help deciding, check out our stock trading guide and choose a broker that suits your goals. Then follow these steps:

  1. Search for the closed-end fund by ticker symbol.
  2. Select the amount of the fund you want to purchase.
  3. Complete your transaction.

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Bottom line

Closed-end funds are easy to buy through an investment brokerage, which offers professional management and historically higher yields than comparable investments. However, that management comes with a price — higher annual fees than other options, such as open-end funds or ETFs.

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