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2 mins Read | 1 Month Ago

Know Difference Between Open Ended and Close Ended Funds

High dividend-paying stocks & Mutual Fund schemes

 

Mutual fund investments in India are of two primary categories: open-ended funds and closed-ended funds. The key differentiator between these two lies in their investment structure and the flexibility they offer for buying and selling. While open-ended funds grant investors the freedom to buy or sell units at any time, closed-ended funds come with some restrictions, allowing purchase only during the NFO period and redemption only after the lock-in period.

Let's look at the definitions and characteristics of open-ended and closed-ended mutual funds.

Closed-Ended Funds

Closed-ended mutual fund schemes lock in your investment for a predefined period. Investors can invest in these schemes solely during the New Fund Offer (NFO) period and can redeem their units only after the lock-in period or scheme tenure expires.

However, some closed-ended funds may transition to open-ended status once the lock-in period concludes or Asset Management Companies (AMCs) might transfer the proceeds to another open-ended fund post-maturity. It's essential to note that such transitions require the consent of the investors in the closed-ended fund.

Investment experts often argue that the lock-in period helps stabilise the fund's assets. This stability grants fund managers the flexibility to create portfolios with long-term growth potential, without the constant concern of outflows through redemptions, which is a common feature of open-ended funds. 

Open-Ended Funds

Open-ended funds, as the name suggests, are perpetually open for investments and redemptions. They represent the most prevalent form of mutual fund investment in India.

Generally, open-ended funds do not impose any maximum limit on Assets Under Management (AUM), making them flexible in terms of accommodating public investments. The Net Asset Value (NAV) of open-ended funds is calculated daily based on the value of the underlying securities at the end of each day.

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

Let's explore the key differences between open-ended mutual funds and closed-ended mutual funds:

Liquidity:

  • Open-ended funds offer high liquidity, allowing investors to buy or sell units at any time, except for Equity-Linked Savings Schemes (ELSS) funds, which have a mandatory 3-year lock-in period.

  • Closed-ended funds lack liquidity during the lock-in period. Redemption proceeds are only accessible after the mandatory lock-in period concludes.

Ways of Investing:

  • Open-ended funds offer flexibility of investing through lump-sum investments and Systematic Investment Plans (SIPs). Investors can make multiple purchases in the fund at their discretion.

  • Closed-ended funds permit investment solely during the NFO period and do not accept investments through SIPs.

Track Record:

  • Investors can assess the track record of open-ended funds by reviewing the historical performance of the schemes they intend to invest in.

  • Closed-ended funds are purchased only during their NFO period, resulting in no available track record for evaluation.

Small Investment Amount:

  • Open-ended funds allow investors to initiate investments with as little as Rs 500 or Rs 1,000 making them accessible to a broader range of individuals.

  • Closed-ended funds typically require a minimum investment of around Rs 5,000 for participating in an NFO.

Rupee Cost Averaging:

  • Open-ended funds offer the benefit of rupee cost averaging through SIPs, enabling investors to accumulate more units when markets are down. This averaging strategy is unavailable in closed-ended funds, as they do not accept investments after the NFO period.

Risk Tolerance:

  • Open-ended funds provide liquidity, allowing investors to react swiftly to market developments. This flexibility can be advantageous for risk-averse investors looking to protect their investments during market downturns.

  • Closed-ended funds, with their lock-in periods, are better suited for investors with a higher risk tolerance and a long-term investment horizon. The absence of liquidity restrictions can offer fund managers more stability in their investment decisions.

Tax Benefits:

  • Equity-Linked Savings Schemes (ELSS), a type of open-ended fund, come with a lock-in period of three years and offer 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, but investors must carefully consider the lock-in period and the alignment of the investment with their financial goals.

In the debate of open-ended mutual funds vs. closed-ended mutual funds, open-ended funds emerge as the superior choice. They offer investors the flexibility to invest according to their financial goals, provide high liquidity and allow for investments with modest amounts. Additionally, the availability of SIPs for open-ended funds facilitates long-term wealth-building.

Open-ended funds align more effectively with investors' evolving needs and financial goals, ensuring they can adapt to market conditions and make investments that suit their circumstances.

Remember, your investment journey should be guided by your aspirations and financial objectives. Open-ended mutual funds can play an important role in achieving those goals.

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