The Mutual fund world is divided into two very different types of mutual funds: open-end mutual funds and close-end mutual funds.  The differences between the two types are significant.  The most important difference is center around how the fund’s shares are traded (purchased and sold by investors).

Creating A Mutual Fund

An open-end mutual fund is created by filing the required paperwork with the Securities and Exchange Commission (SEC).   Once the SEC has accepted the filing (FYI, the SEC only accepts filing and they DO NOT approve a filing) then the mutual fund may solicit money from investors for shares in the mutual fund.  Once the mutual fund has some money to invest they buy various securities that fit with the investment objectives of the mutual fund.

Buying and Selling Shares in an Open-End Mutual Fund

Open-end mutual funds are the most common form of mutual fund and is generally to what we refer as a mutual fund.

When an investor buys or sells a share in an open-end mutual fund, the investor is buying shares directly from the mutual fund and the investor is selling shares back to the mutual fund.  All the buying and selling of shares happens at the end of each business day (called a trading day).  Specifically, when an investor buys shares from a mutual fund the fund is issuing new shares to the investor.  When an investor sells shares back to the mutual fund the fund is redeeming those shares from the investor.  That means the total number of shares of the mutual fund is constantly changing because every trading day different number of shares that are issued or redeemed.

The price of the shares that are bought and sold each day is determined by the value of the securities owned by the mutual fund (aka net asset value or NAV).  When an investor buys shares of a mutual fund the fund will then invest those dollars into more securities that the fund owns in their portfolio.  When an investor sells shares in a mutual fund the fund will sell some of their securities to pay for those shares.  In many cases, the mutual fund will use incoming cash from shares sales to pay for the share redemptions and if any cash remains then that cash will be used to invest in additional securities.  This activity is often referred to as fund flows which describes the net amount of cash flowing into or out of a mutual fund.

Buying and Selling Shares in a Closed-End Mutual Fund

A closed-end mutual fund initially issues a fixed number of shares in the fund for investors to purchase which gives the closed-end mutual fund a fixed amount of capital to manage inside the fund.  When investors want to buy or sell shares in a closed-end fund, they trade those shares on the open market with other investors that are selling or buying shares in the fund.  This is a very different process from open-end funds.  With the shares of closed-end funds on an open market then the price of those shares are constantly changing during trading days.  The portfolio managers of closed-end funds also have the benefit of not having to issue and redeem shares each day which allows them to keep the fund’s capital invested.

Closed-end funds are priced based on both the fund’s net asset value (NAV) along with the supply and demand of shares available to trade as well as the expectations of investors.  All of these things combine to price shares of closed-end mutual funds that can be very different from the NAV of the shares.

So What

We, and most definitely the press, often refer to mutual funds without regard to specific funds and an independent investor should be aware that mutual funds can have some significant differences.  An investor must be aware of the differences so they can execute their plans by using investing tools that they understand.  If we want to write a letter and pick up paint brush, we won’t be successful in writing a letter.  Both types of mutual funds are very good investment tools but they can behave very differently and potentially create different results and we as independent investors must know our investment tools.

And here’s the necessary legal & compliance stuff:

Disclosure & Disclaimer

I am a practicing certified public accountant (CPA) and am licensed in the states of Oregon and Washington and own a CPA firm, CPA Worx LLC, and have practiced for more than 25 years.  I teach accounting at Oregon State University and have taught at the college/university level since 1997. 

I also own a registered investment advisory firm, Peacock Investment Worx LLC.  In the $100 Investor project, I am not offering recommendations of any kind nor am I providing tax, accounting, or legal advice.  I do not receive any type of compensation, of any kind, from the brokers, companies, mutual funds, exchange traded funds, websites, authors, publishers, investment managers, or anything or anyone else that I mention in this project.  True, my clients compensate me for my work and advice.  Many people do not want to invest on their own so I provide my investment services for a fee through Peacock Investment Worx LLC.  But the $100 Investor project is my way of helping anyone and everyone that wishes to invest on their own.  I want to support the independent investor.

Peacock Investment Worx LLC can be found online at www.peacockinvestmentworx.com and on Facebook at 100 Dollar Investor.

CPA Worx LLC can be found online at www.peacockcpaworx.com and on Facebook at CPA Worx.