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Advantages & Disadvantages of Closed-End Funds

Original post by Kathy Adams McIntosh of Demand Media

Closed-end funds pose several advantages and disadvantages to investors, who evaluate many factors in deciding where to deposit their money. Investors choose between funds and individual securities. With a fund, managers oversee its performance and choose which securities the fund buys and sells. The investor makes no decisions regarding individual securities when she purchases shares of a fund.


A closed-end fund offers a limited number of shares for sale to investors. These are the only shares issued by the fund. The investor relies on the fund manager to make profitable decisions when purchasing new securities or selling stock. The investor generally owns his shares until the fund is liquidated. The investor recognizes income when the fund liquidates and he receives his share. If the liquidation payment exceeds the price he paid, the investor has realized a gain. If the purchase price exceeds the liquidation payment, the investor has lost money.


In addition to purchasing shares of a closed-end fund directly from the firm, an investor can purchase shares of the fund on the stock exchange. The selling price of each share traded on the stock exchange varies throughout the day. The investor decides whether the selling price per share represents a value for her, and how many shares to purchase. After the initial issuance of shares from the firm, this is the only way to buy shares in a closed-end fund.


The advantages of investing in a closed-end fund include the manager’s ability to make long-term decisions. and potentially discounted prices. The fund manager evaluates his buying decisions based on expectations for each security’s long-term performance rather than on short-term gains. These funds often sell at a discount, creating an instant gain for the investor.


The disadvantages of investing in a closed-end fund are the investor’s inability to redeem the shares, and the possibility of poor management. To receive money from the investment before its liquidation, the investor cannot request payment from the company. He needs to sell his shares to a buyer on the stock exchange. Also, the fund manager controls the fund activities. If the manager makes poor decisions, the investor pays the price.



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