Difference Between Open Ended and Closed Ended Mutual Funds: Which is Better?

Open Ended Vs Closed Ended Mutual Funds: An Overview

Mutual funds are a popular sort of investment favored by millions of individuals worldwide due to the diversification they provide at a reasonable cost. Mutual funds are classified according to their features, which include, among other things, the potential risk, the type of the investment, and the asset class upon which the investment is based.

Based on their investment structure, or if they are open-ended funds or closed-ended funds, mutual funds in India are classified into two kinds. The degree of investment freedom and the simplicity with which they may be purchased or sold determine whether a fund is open-ended or closed-ended. Contrary to closed-ended funds, which can only be purchased at the time of its inception and can only be retrieved when the fund's investing term has expired, an open-ended mutual fund is one that has the flexibility to be purchased or sold at any time.

Fundamentals of Open-Ended Funds

Let us understand the basic fundamentals of open-ended mutual funds in India.

Open-Ended Funds Meaning

Open-ended mutual funds are a type of mutual fund in which there is no time limit for entering or exiting. The units sold or acquired in such funds are determined by the net asset value, or NAV. NAV fluctuates daily i.e. (at the conclusion of every trading day in the market, in response to changes in the market values of bonds and equities. These schemes purchase and sell the fund units on a regular basis, allowing investors to move in and out at their convenience. The fair market value of open-ended fund investments is the same as the closing market price of publicly listed securities. Also, these funds do not have a set maturity date.

Open-ended funds are appropriate for investors who want to put their money into a liquid investment vehicle and are prepared to take on market and cash flow risk in exchange for high rewards.

Benefits of Open-Ended Mutual Funds

• Liquid Investment: Open-ended funds have high liquidity, making it possible for you to redeem your units whenever you choose. Open-ended funds, in contrast to other forms of long-term investments, offer the flexibility of redemption at the current Net Asset Value (NAV).
• Track Records: Open-ended funds have available performance data that can be traced back several years. Consequently, choosing to invest in an open-ended fund seems like a wise choice.
• Systematic Investment Plan: Funds that demand lump sum deposits from investors at the time of the fund's introduction might be a dangerous way to handle your capital. Open-ended funds, however, are a good investment choice for many individuals in the salaried class. This is so because people may invest through SIPs (systematic investment programs), as provided by open-ended funds.

Disadvantages of Open-Ended Mutual Funds

• Exposure to Market Risk: Open-ended funds are vulnerable to market risk even though their fund managers maintain a portfolio that is highly diversified. The fund's NAV continuously changes in response to changes in the underlying benchmark.
• No Choice in the Asset Allocation: Fund managers for open-ended funds are chosen based on their qualifications and prior fund management experience. They make all selections of securities for the fund-related judgments. As a result, the fund's asset allocation is decided without the input of the investors.
• Exit Loads: Exit loads are also applied to open-ended funds. These fees are imposed on you if you withdraw money from the fund before a predetermined time period, usually up to a year. Therefore, if an open-ended fund is subject to capital gains tax, the final earnings will be lower.

Fundamentals of Closed-Ended Funds

Let us now understand about the basic nitty-gritty of closed-ended funds in India by delving into their features, advantages and disadvantages.

Closed-Ended Mutual Funds Meaning

Mutual fund programs that are closed-ended allow investments only during the fund's NFO term. After the NFO period has ended, investors are not permitted to make any investments. These funds are initially offered for a set period of time, such as three or seven years, after which assets are liquidated and investors receive their money back along with any gains (or losses) from their investments. Additionally, during the life of the plan, investors can conduct buy/sell transactions on stock markets where these funds are listed. Depending on their level of risk tolerance, investment horizon, and financial objectives, investors can choose to invest in these funds.

Benefits of Closed-Ended Mutual Funds

• Provides a Systematic Approach to Investing: The mutual fund scheme's set maturity encourages disciplined investment because units are maintained until they mature. This contributes to the capital growth and long-term growth of your money.
• Market Prices are Accessible: Closed-ended funds are often traded on stock markets like equity shares. This gives investors the chance to purchase or sell fund units at real-time prices that may be beyond (premium) or even below (discount) the fund's NAV. Additionally, they can employ common stock trading techniques like market/limit orders and margin trading.
• Stability of AUM: After the NFO period has expired and until the scheme's maturity, the investments in closed-ended funds continue to be stable. Better returns are produced for investors as a result of the fund management not having to liquidate holdings to cover redemptions.

Disadvantages of Closed-Ended Mutual Funds

• Investment in a Lump Sum: When investing in closed-ended funds, you must make a single, large investment. Utilizing this strategy to manage your money might be dangerous. It leads you to place larger wagers than would otherwise be justified. Additionally, a significant portion of investors in the paid class cannot pay lump sum investments. Instead, they favor sporadic investments made through systematic investing (SIP).
• Returns with a fixed maturity limit: Over very long periods of time, equity assets may produce exceptional returns. In closed-ended funds, the units are redeemed at the fund's predetermined maturity, which is after 5,7 years, dispelling the notion of higher long-term investment. This restricts the larger returns that would be possible if units are retained for extended periods of time.
• No Prior Records: Closed-ended funds don't have any performance history. Investors lack historical performance information at the time of the NFO debut since these plans are closed after one set period of maturity.

Open-End vs Closed-End Mutual Funds

The following table represents a point of comparison between open-ended and close-ended funds so that you can compare the two and choose a viable investment opportunity based on your suitability and preferences.

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For investors, especially those who are novices, open-ended plans are the best option. It frequently offers a number of advantages, such as the ability to diversify your assets, keep them in line with your risk tolerance, and retain liquidity by allowing one to withdraw money from their holdings at any moment. Closed-ended funds, in contrast, are traded on an exchange just like any other stock, which is unsettling for a novice investor. Due to insufficient liquidity, it may be difficult to sell one's units, even when you are in a dire financial situation. However, To make the best decision, one must discern between the schemes offered by the various types of mutual funds, and look for a diversified portfolio based on their suitability and risk appetite.