When talking about mutual funds, the majority of time we are talking about open ended mutual funds. This is important to know because sometimes, new investors hear the term open ended mutual funds and think this is a new type of investment. It’s not. It’s just your standard mutual fund. What are the characteristics of open ended mutual funds and should you invest in them? I answer these questions and more below.
Open Ended Mutual Funds
An open ended mutual fund is your common mutual fund. It is termed open ended because there are an unlimited (in theory) number of shares in a given mutual fund. What does this mean? When you buy into a mutual fund, new shares are created just for you. When you sell shares, those shares are retired.
This is the opposite of what happens with stocks. With stocks, a company issues a set number of shares. If you want to buy a share of the issued stock, you have to find someone willing to sell their shares to you. New shares are not just created for you. Likewise, if you want to sell, you have to find a buyer for your shares. For the most part, this is not an issue. Shares are traded so frequently that finding a buyer or a seller is easy. But if you own stock in an obscure company, it might take some time to actually buy or sell your shares.
In summary, with open ended mutual funds, you can buy and sell shares at will. You do not need to have someone else on the other end of the transaction – the mutual fund acts as the other party. With stocks, you need to have someone else on the other end of the transaction.
Why Open Ended Mutual Funds Shares Are Not Unlimited
I mentioned above how the shares in open ended mutual funds are unlimited. This is only technically true. I’m sure you have heard about a mutual fund closing to new investors. This happens when the stock market or a given sector is hot and investors are buying more shares at a rapid pace. The mutual fund can’t keep up with demand for a few reasons:
- When new money comes into the fund, the mutual fund has to go out in the market and buy more of the underlying securities. If a flood of new money comes in, the mutual fund could technically force prices higher, hurting the fund in the long run.