Open-Ended vs. Closed-Ended Mutual Funds: Key Differences

Mutual funds are investment funds that pool money from many investors to purchase securities. Mutual funds often come out with numerous schemes and with different investment objectives which are launched from time to time. A mutual fund must be registered with the Securities and Exchange Board of India (SEBI) which regulates securities markets before it can collect funds from the public. Investment in mutual funds is a mechanism for pooling resources by issuing units to the investors and so the profits or losses are shared by the investors in proportion to their investments. 

Table of Content

What is an Open-Ended Mutual Fund?

• What is a Close-Ended Mutual Fund?
• Key Differences Between Open-ended and Close-ended Mutual Funds

Investors of mutual funds are known as unitholders. There are different investment avenues available to investors. Mutual funds investment offers a good opportunity to enhance one’s wealth however, there are certain risks involved in it too. While making investment decisions you must read all scheme-related documents carefully. As an investor, you should also compare the risks and expected yields.

A mutual fund scheme can be classified into an open-ended scheme or a close-ended scheme depending on its maturity period. The objective of this blog is to make investors aware of the difference between open-ended and closed-ended mutual funds so that they can make the right investment decisions. 

What is an Open-Ended Mutual Fund?

This type of mutual fund allows you to buy or sell units on any business day. It is also the most prevalent form of mutual fund investment in India. There are no set limits, and neither do they have any fixed maturity or lock-in periods. This gives you the flexibility to make investment decisions accordingly. The Net Asset Value (NAV) of open-ended mutual funds is the daily calculation based on the value of the underlying securities at the end of each day.

What is a Close-Ended Mutual Fund?

In this type of mutual fund, units are not available for purchase or sale at any time. The scheme allows you to invest only during the New Fund Offer (NFO) period and redeem the investment after the maturity period is complete. Close-ended mutual fund schemes lock in your investment for a predefined period. 

Both open-ended and close-ended mutual funds are professionally managed to achieve diversification by investing in a collection of equities rather than investing in a single stock. 

Key Differences Between Open-ended and Close-ended Mutual Funds

Meaning

• Open-ended fund offers the sale and purchase of units at any time. 

• Close-ended fund allows you to invest solely during the NFO period and redeem investments after the maturity period.

Liquidity

• Open-ended funds offer high liquidity.
• Close-ended funds lack liquidity during the lock-in period.

Ways of Investing

• Open-ended funds offer flexibility in investing through lump-sum investments and systematic investment plans (SIPs). As an investor, you can make multiple purchases in the fund.
• Closed-ended funds do not accept investments through SIPs.

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Track Record

• While investing in open-ended funds, you can assess the track records and review the performance of the schemes you want to invest in.
• There are no track records for evaluation while investing in close-ended mutual funds.

Investment Amount

• Open-ended funds allow investment as little as Rs 500 or Rs 1,000 making it accessible to a broader range of individuals.
• Close-ended funds typically require an investment of Rs 5,000 to make purchases during the NFO period.

Cost Averaging Strategy

• Open-ended mutual funds offer the benefit of rupee cost averaging through SIPs, which enables an investor to accumulate more units when markets are down.
• The above averaging strategy is unavailable in close-ended funds.

Risk Tolerance

• Since open-ended funds offer high liquidity, it allows investors to react swiftly to market developments. This flexibility can be advantageous for investors who are reluctant to take risks and want to protect their investments.
• The absence of liquidity restrictions in close-ended funds offers fund managers more stability in their investment decisions. These types of schemes are best suited for investors with a higher risk tolerance and a long-term investment horizon.

Tax Benefits

• Equity-Linked Savings Schemes (ELSS) are an example of an open-ended mutual fund which comes with a lock-in period of three years and offers tax benefits under Section 80C of the Income Tax Act. This makes ELSS funds a preferred choice for tax-saving purposes.
• Closed-ended funds can also provide tax benefits. However, investors must carefully consider the lock-in period and the alignment of the investment with their financial goals.

The differences between an open-ended and a close-ended mutual fund prove that both have their advantages as well as disadvantages. However, in most cases, open-ended funds emerge as the superior choice but one needs to make an informed decision, compare both to assess the risk-reward ratio and choose the scheme that best aligns with your financial goals.