An open-end fund is a diversified portfolio of pooled investor money that can issue unlimited shares. The fund sponsor sells shares directly to investors and redeems them as well. These shares are priced daily based on their net asset value (NAV). Most mutual funds and exchange-traded funds (ETFs) fall into this category.
They overshadow their counterpart, closed-end funds, and are a staple in company-sponsored retirement plans like 401(k) plans.
Key Takeaways
- An open-end fund is an investment utilizing pooled assets, allowing for continuous new contributions and withdrawals.
- Due to this structure, open-end funds have a theoretically unlimited number of potential shares outstanding.
- Most mutual funds and ETFs are categorized as open-end funds.
- Open-end mutual fund shares do not trade on exchanges and are priced daily at their portfolio’s net asset value (NAV). ETFs trade throughout the trading day.
How an Open-End Fund Works
An open-end fund issues shares if buyers seek them and is always open to investment. When you purchase shares, the fund creates new shares. Conversely, selling shares removes them from circulation. The value for buying and selling these shares on demand is determined by their NAV, calculated at the end of each trading day.
Investors benefit from a simple, low-cost way to pool money and access a diversified portfolio. Investment goals for open-end funds cover a broad spectrum, including growth, income, large-cap, and small-cap stocks, among others. They can also target specific industries or countries. Generally, entry into an open-end fund does not require substantial funds.
Occasionally, a fund may close to new investors if its management believes its assets are too large to achieve its goals. In exceptional cases, the fund’s investors might decide to convert it into a closed-end fund.
Open-end funds are almost synonymous with mutual funds, making them so familiar that many investors overlook their variations. That’s because most mutual funds and ETFs today are open-end, even though pooled investments were historically closed-end until the 1970s.
Difference From Closed-End Funds
Closed-end funds launch through an initial public offering and trade their shares on exchanges. These shares trade at a discount or premium to their NAV, based on supply and demand throughout the trading day.
Closed-end funds may have higher costs at times due to wider bid-ask spreads for illiquid funds, and their price could fluctuate more sharply than their NAV suggests. Trades for closed-end fund shares are conducted through a broker.
Pros and Cons of Open-End Funds
Both open- and closed-end funds are usually managed by portfolio managers and analysts. They mitigate security-specific risk by maintaining diversified portfolios and lowering investment and operating costs through pooled resources.
However, open-end funds must maintain sufficient cash reserves to meet shareholder redemptions, potentially leading to lower yields as these reserves remain uninvested. Although management fees are higher due to continuous adjustments to meet investor demand, open-end fund investors benefit from greater flexibility in buying and selling shares owing to constant market-making by the fund family.
Pros
- Diverse portfolios that reduce risk
- Professional money management
- High liquidity
- Low investment minimums
Cons
- Need for high cash reserves
- Potentially high fees and expenses (especially if actively managed)
- Generally lower yields compared to closed-end funds
Real World Example of an Open-End Fund
Fidelity’s Magellan Fund, one of the company’s pioneering open-end funds, focuses on capital appreciation. Established in 1963, it became famous in the late ’70s and ’80s for consistently outperforming the stock market. By early Q2 2024, it boasted a lifetime average annual total return of 15.8%.
The fund’s portfolio manager, Peter Lynch, catapulted to fame, and the fund accumulated $100 billion in assets, prompting Fidelity to close it to new investors in 1997. It reopened in 2008.
FAQs on Open-End Funds
Can You Sell Back Shares of an Open-End Fund?
Yes, as an investor, you can generally sell your shares back to the fund at any time based on the present NAV.
Are Open-End Funds Regulated?
Yes, these funds are under regulatory oversight by entities like the U.S. Securities and Exchange Commission to ensure investor protection.
Do Open-End Funds Pay Dividends?
Yes, open-end funds can pay dividends from the income their investments generate, which investors can choose to reinvest or receive as payouts.
What Impact do Investor Redemptions Have on an Open-End Fund?
Redemptions can lead the fund to sell assets to meet withdrawal demands, potentially affecting its composition and performance.
The Bottom Line
Open-end funds are a favored choice for investors seeking diversification and flexibility. Allowing unlimited shares, these funds are priced relative to the NAV, calculated daily at the end of trading. They offer significant advantages such as liquidity and a broad range of investment options, though they come with management fees and potential impacts from investor redemptions on performance.
Related Terms: closed-end fund, mutual fund, net asset value (NAV), portfolio management.
References
- H. Kent Baker, et al. “The Savvy Investor’s Guide to Building Wealth Through Traditional Investments”, Pages 126-128. Emerald Publishing Limited, 2020.
- The Federal Reserve. “Financial Accounts of the United States”.
- Ed Moisson, “The Economics of Fund Management”, Pages 142–4, 148–9, 157, 235. Agenda Press, 2024.
- Closed-End Fund Association. “Overview”.
- Fidelity. “Fidelity Magellan Fund”.
- Fidelity. “Lessons From an Investing Legend”.
