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Open and closed end mutual funds and classes of funds

By David Luhman on Sat, 05/09/2009 - 23:54

Open and closed end mutual funds and classes of funds

Closed-End Funds

If you're thinking about investing in funds, note that with over 6,000 funds there's plenty of choices. So let's look at these funds by categorizing them by type. The first way to categorize funds is into either open-end or closed-end funds.

The vast majority of mutual funds available are called open-end funds. Open-end funds always sell at the value of their underlying holdings.

If an open-end fund receives new money from investors, the fund issues new shares to the investor. Conversely, the investment company also buys back shares from investors cashing out, so the number of shares in the open-end fund is constantly changing.

Closed-end funds, on the other hand, do not issue new shares on a daily basis. Shares of closed-end funds trade at a premium or discount to their underlying value on traditional stock exchanges like the New York Stock Exchange.

Although closed-end funds have their fans, I'd recommend that you stick with the much more popular open-end variety. For the rest of this tape, I'll be talking about investing in open-end mutual funds.

Long-term returns

You also can categorize funds according to their underlying assets. When you do this you generally split funds into money market funds, bond funds and stock funds, although other funds like real estate funds exist.

For most of the 20th century, inflation has averaged about 3 percent a year, short-term Treasury bills have returned 4 about percent per year, long-term bonds have returned about 5 percent and stocks have returned about 10 percent annually.

So short-term money market securities and long-term bonds have only slightly beaten inflation, while stocks have easily beaten inflation.

But don't forget taxes. After inflation and taxes, both money market securities and bonds would have given you a negative return. Even after taxes, however, stocks still show a positive return.

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