Closed-End Mutual Funds

Closed-end mutual funds are mutual funds that have a specific amount of shares for sale, and once these shares are sold to investors, you can't redeem them through the fund. You buy and sell closed-end fund shares with other investors, through the same process you use with any corporate stock. The shares trade on stock exchanges and you buy and sell these shares through your broker just as you would with other shares. The mutual fund itself isn't involved in the process.

Closed-end mutual funds are much different from other mutual funds, which are open-ended--you buy shares from and sell shares to the mutual fund itself. Unless a fund is labeled as closed-end, it is an open-end mutual fund.

There are several categories of closed-end funds, including sector funds, global funds, corporate bond funds, government bond funds and growth funds.

Advantages of closed-end funds. What's the advantage of investing in closed-end funds when you can simply invest in the underlying shares? Well, they are professionally managed mutual funds, and you have the convenience of automatic reinvestment of dividends and gains. Ultimately, your primary goal should be to put your money in investment vehicles that have a history of reaching their investment objectives.

Another possible advantage to investing in closed-end funds is that, in an ideal situation, you can buy shares at a discount from the underlying fair market value and sell shares at a premium over the underlying fair market value. This strategy isn't possible with open-end funds because their shares buy and sell at their underlying fair market value. Of course, this strategy is far from easy to implement because you have to buy the shares when a fund is running into trouble and sell the shares when a fund is in demand due to its rising performance or some characteristic that sets it apart from other funds, making it a must-have for many investors.

Planning Note You may want to avoid buying new offerings from a closed-end fund. Why? These shares typically sell at a premium over fair market value because the fund has to pay fees to the brokers underwriting the shares. (An investment underwriter assumes the risk of buying new securities from an issuing company or government entity and reselling them to the public.) Also, the underwriters tend to heavily push these shares when they are first issued and then taper off in favor of other investments. For these two reasons, the funds' prices can quickly fall to a discount from the underlying fair market value. This doesn't mean you should never purchase new offerings, but you should be aware of the above caveats.