A look at closed-end funds vs. open-end funds

Closed-end funds are generally not for hands-off investors. But they can offer benefits over more common open-end mutual funds, if an investor is willing to take on the added risks and rewards from differences in how they operate. Here’s a look at key differences:

OPEN-END FUNDS:

HOW THEY WORK: The fund issues as many shares as investors demand. When an investor buys in, they pay the fund’s current share price, based on the value of the fund’s investment holdings at the end of the trading day.

REWARDS: Investors exiting a fund can quickly get their money out at the current market value of the fund’s holdings, known as the fund’s net asset value. Funds often reduce the expenses they charge investors as the fund grows, for more efficient investing.

RISKS: In falling markets, managers sometimes see a surge of investors redeem their money. That can force the manager to sell investments at inopportune times as prices are falling, eroding remaining investors’ returns. Also, managers hold some of their portfolios in cash. That inability to stay fully invested means open-end funds can lag in market rallies, depending how much cash they’re holding.

CLOSED-END FUNDS:

HOW THEY WORK: The fund issues shares through an initial public offering, much like a corporate IPO. The number remains fixed, and investors can buy or sell shares like stocks during daily trading sessions. Depending on whether the market favors buyers or sellers, shares can change hands at a discount to the value of the fund’s assets, or at a premium.

REWARDS: Closed-end funds typically sell at a discount of 1 percent to 10 percent, so savvy investors can see their returns magnified beyond any appreciation in the fund’s assets.

For example, consider a bond fund paying out a 10 percent dividend on its assets, which are valued at $10 a share. If the fund is trading at a 10 percent discount, a $9 investment gets you not only the dividend, but also savings from shaving a buck off the purchase price. If the discount turns to a premium by the time you sell, you’ll fare even better.

Closed-end funds also are more likely to stay fully invested and hold minimal cash, so they’re less likely to miss out on investment opportunities in rising markets.

RISKS: Investors getting out of a closed-end fund during a buyers’ market must sell at a discount. That will erode any returns from investment gains. Also, anyone investing in a fund when it’s priced at a premium is less likely to see gains than someone buying at a discount. Because closed-end funds typically have fewer investors and smaller asset totals than open-end funds, their costs can often be higher. Some closed-end funds hold illiquid investments that may drop sharply in value in a falling market.