What are Open-Ended Mutual Funds? Benefits, Risks, and How They Work

Open-ended mutual funds, as their name suggests, are always open to investment. Unlike traditional investment options with fixed durations, these mutual funds offer the flexibility to enter and exit as per your will. So, how do open-ended funds work and what makes them a popular choice? Let’s explore this in detail.

What are Open-Ended Funds?

Mutual funds are broadly classified into open-ended mutual funds and close-ended mutual funds. Of the two, open-ended funds are more popular among investors.

These funds allow investors to buy and sell mutual fund units at any time based on the fund’s daily net asset value (NAV). The NAV is calculated at the end of each trading day based on the closing prices of the underlying securities.

Open-ended mutual funds issue and redeem shares based on investor demand. There is no cap on the number of shares the fund can issue, unlike close-ended mutual funds. These funds don’t have a maturity date.

Open-ended funds offer high liquidity and are suitable for investors who want flexibility in their investments.

How Do Open-Ended Mutual Funds Work?

All mutual funds are floated through a new fund offer (NFO), and the same goes for open-ended funds. Once the NFO period is over, you can start buying and selling the units of the open-ended mutual funds. 

Investors can buy units from the fund or redeem them at the prevailing NAV. But remember NAV can fluctuate based on market conditions and performance of the underlying investments.

Open-ended funds are managed by professionals who make decisions based on the fund’s investment objectives. You can choose to invest in open-ended funds through a Systematic Investment Plan (SIP) or as a lump sum. 

These funds have management fees and other expenses that affect returns.

Advantages of Open-Ended Mutual Funds

Here are the top advantages of investing in open-ended funds:

High Liquidity: Since you can buy and sell mutual funds units on any working day, it means you can liquidate your investments whenever you choose. This feature provides investors with quick access to funds.

Transparency: Investors can easily access information about the securities held in the fund, its historical performance, and the track record of the fund manager. This transparency allows investors to make an informed investment decision. 

Convenience: Open-ended mutual funds allow you to invest via SIP, STP or as a lump sum. This gives investors the convenience to invest as per their financial goals. 

Professionally Managed: Since these funds are professionally managed, it saves you the hassle of actively tracking the market. These managers analyse market conditions, research potential investments, and adjust the portfolio according to the fund’s investment objectives.

Disadvantages of Open-Ended Mutual Funds

Here are the key disadvantages of open-ended mutual funds:

Market Risk: Open-ended funds are vulnerable to stock market fluctuations, which can impact the value of the investment. Even if the fund manager diversifies the investments, he/she cannot eliminate stock market risk.

Vulnerable to Huge Inflows & Outflows: Unlike close-ended mutual funds, these schemes can see huge inflows and outflows. Quick outflows may force the mutual fund manager to sell the securities at unfavourable prices, causing huge losses for investors in the scheme.

Exit Load: When selling units of mutual funds, there is often an exit load fee, which is a percentage of the unit's value. This fee is levied if you exit the fund within a certain period. This can potentially reduce returns for your mutual funds.

Who Should Invest in Open-Ended Funds?

Open-ended funds are suitable for a wide range of investors. Those who are seeking high liquidity and flexibility in their mutual fund investments will find open-ended funds attractive. However, an investor should keep in mind their risk profile, investment objectives and tenure before choosing a fund. 

Open-Ended vs Closed-Ended Funds: Key Differences

Here are the key differences between open and close-ended mutual funds:

How to Redeem Open-Ended Mutual Funds?

You can redeem your mutual fund units at any time at the current NAV of the fund. However, you may have to pay some charges if you exit the fund during the exit load period. 

Since Equity-linked Saving Schemes (ELSS) have a lock-in period of three years, you cannot redeem these units until this period is over. You can sell them once the lock-in period comes to an end like other open-ended mutual funds.

Taxation on Open-ended Funds

Any capital gains earned from mutual funds are subject to taxation. The rate of tax applicable will vary depending on whether the fund is an equity fund or a debt fund. 

Taxation of Equity Funds

If the fund invests at least 65% of its assets in equity funds, then it is treated as an equity fund for taxation purposes. The quantum of tax will depend on your holding period.

Short-term capital gains: If you sell your mutual fund units within 12 months, the gains are known as short-term capital gains. They are taxed at 20%.

Long-term capital gains: If you sell your mutual fund units after 12 months, the gains earned are called long-term capital gains. You don’t have to pay any taxes on gains up to ₹1.25 lakh in a financial year. While returns above that are taxed at 12.5%.

Taxation of Debt Funds

If the fund holds 65% of its total corpus in debt instruments, then it is treated as a debt fund for taxation. The taxation for debt funds is as follows:

Investments made on or after April 1, 2023: Gains made on debt funds will be taxed as per the investor’s income tax slab rate irrespective of the holding period.

Investments made before April 1, 2023: Herein, taxation on gains made will be determined by the holding period. If you sell your mutual fund units within 24 months, gains will be taxed at your prevailing income tax slab rate. However, if you sell your fund after 24 months, you will have to pay a tax of 12.5% (no indexation benefit) on your returns.

Conclusion

Open-ended mutual funds are popular among investors as they offer liquidity, convenience, and transparency to investors. That said, it is important to consider the risks associated with mutual fund investments. You should analyse your investment tenure, risk profile and financial objective as well. 

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