Open Ended Mutual Funds and Closed Ended Mutual Funds – Comparative Analysis

Mutual funds is the talk of the town, there is no denying that. However, it can be a bit confusing especially when you have various types of it like open-ended and close-ended. This blog addresses the differences between both and how to choose the best one.

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Introduction

A mutual fund is a collective investment scheme. It raises money from investors and invests it in stocks, bonds, money market instruments and other assets. In other words, mutual funds provide an opportunity to investors to earn an income or build their wealth through professional management of funds. The money for mutual funds is managed by a team of experts also known as professional fund manager or portfolio manager. They are specialized with financial knowledge and skillsets to deal the investors’ money as a professional.

There are various type of mutual funds available. Investors can choose any kind of mutual fund scheme based on their risk profile, investment plan and goals. Mutual fund offers multiple investment options like one time investment or instalments via a Systematic Investment Plan (SIP). Most mutual fund schemes are liquid and cost-efficient.

Mutual funds are classified into various types on the basis of its structure, asset class, investment plans and risk profile. Based on structure mutual funds are divided into:- Open-ended, Close-ended and Interval funds. The fundamental difference between an open-ended mutual scheme and a close-ended mutual scheme is that open-ended fund scheme offers new units to the investors on continuous basis, there is no fixed maturity period. A close-ended fund scheme offers new units for a limited period of time.

Also read: What is a Mutual Fund and How Does it Work? (Complete Guide)

Open Ended Mutual Funds

• Open-ended mutual funds are available for repurchase and subscription continuously. It will issue the share to investors on the basis of net asset value(NAV) per share. According to guidelines, investors can purchase share from the mutual fund rather than from existing shareholders.
• An investor can purchase or sell units at any time after the NFO period ends.
• This scheme does not have any limitation on the number of shares issued by the fund.
• There is no maturity period for open-ended mutual funds.
• An open-end mutual fund is a good option to the people who wish to start investments with tiny amount.
• Investors can invest via SIPs.

Benefits and Disadvantages

• Liquidity: Investors can redeem their units of the funds at any time they want. Moreover, the investors can redeem the units as per the net asset value.
• Systematic options available: It allow investors to make use of various systematic plans (SIPs, SWPs and STPs), for investments and withdrawal.
• Professionally and experienced management: Highly skilled and experienced fund managers to make the right investment decision for the investors.
• Higher returns: Provides higher returns to investor with a short-term investment.
• Open-ended funds do not have any fixed maturity period.
• These funds are not traded on stock exchanges.

Also read: Mutual funds vs Fixed Deposits: Which is better?

Close Ended Mutual Funds

• Investors can purchase the units of a close-ended mutual fund scheme only during the new fund offer (NFO)period. The units can withdraw only after the tenure of the scheme is over.
• A Closed-ended fund is a type of investment company whose shares are traded on the open market like an exchange-traded fund (ETF).
• Closed-ended funds are appropriate for investors who are interested in long term investments.
• The maturity period of a closed-ended is 3 to 7 years.

Benefits and Disadvantages

• Stability: Investors can redeem their units of the fund after the expiry of the maturity period. This will help the fund managers to not worry about the frequent cash inflows and outflows. It will provide an opportunity for the fund manager to create a strategy to achieve the investment goals of the plan.
• Market Price based on demand and supply: Units of these schemes are sold on the trade at prices determined by the demand and supply of the units of the scheme.
• Long term investment option: This will be a better option for investors with a long-term investment plan.
• Under this scheme, investor will not be able to sell their units of the fund in case of emergency.
• There is no provision for Systematic Investment Plans(SIPs).This increases risk among investors.

Also read: Performance Evaluation of Mutual Funds

Comparison Between Open-Ended and Close-Ended Mutual Funds

• An open-ended fund is an excellent option for investors to buy or sell the units any time from mutual fund house whereas, close-ended funds have a fixed maturity period to purchase or sell the units from the organized stock exchange.
• Open-ended schemes offer an option to invest in small amount through SPIs, whereas this facility is not available under close-ended scheme.
• The great difference between open-ended and closed-ended mutual funds, is that open-ended funds offer high liquidity compared to closed-ended funds.
• Investors who have interest in investing for long term period, they can opt close-ended funds that offer high stability.

Also read: Entri Finacademy is Now SEBI Compliant!

Tax Implications

Tax is an additional baggage when it comes to anything involving income. Under the rules set by the government you are bound to pay taxes on the basis of your income. When it comes to mutual funds, the tax treatment can vary according to the type of fund and how the investment is structured.

Tax on open-ended mutual funds

When a mutual fund sells investments (like stocks) and makes a profit, it distributes some of that profit to the investor (you). This profit is also known as capital gain. You will have to pay taxes on this capital gain. Another aspect is the taxes based on long-term and short-term investments. If you sell an investment within a year, it is considered as a short-term gain and will ne subjected to a higher tax rate. If you sell it after a year, it is considered as a long term gain and the tax rate imposed will be lower.

Other than capital gains, you have another income source called dividends. Dividends are income paid by the mutual funds from stocks or bonds they hold. As you have guessed, these are also taxed. Dividends are divided into 2: qualified and non-qualified dividends. Qualified dividends, which are usually from stocks held more than 60 days, receive a lower tax rate. Whereas, non-qualified dividends, which are from other types of investments are taxed at regular income rates.

Tax on close-ended mutual funds

Similar to open-ended funds, close-ended mutual funds also can make profits from selling investments. If these profits are passed on to you, you would have to pay taxes. However, close-ended funds are traded on the stock market, so the profit that you receive will be based on the price you paid for the fund’s shares. Even if the price of the close-ended fund goes up, you might pay taxes when you sell those shares for a profit.

Tax on dividends received from close-ended funds will be similar to that of those received from open-ended fund.

Also read: Best Mutual Fund Apps for Investment in India

Conclusion

Sometimes it may be a challenge to investors to choose a mutual fund scheme for investment goals. Nevertheless, one can decide their investment based on the performance of the fund. It is driven by nature of the fund, fund manager and their investment philosophy. Before investing in a mutual fund is very important to set a financial purpose. This will help the individuals can choose a fund scheme based on their investment plan.

If you feel like you need more knowledge about mutual funds, check out Entri Finacademy’s mutual funds course. With industry experts and top quality materials, you can easily master mutual funds course in no time. You can also check out other courses like the forex trading course and the stock market course. Enrol now, and start your journey towards financial independence.