Mutual funds are broadly classified into open-ended and close-ended mutual fund schemes. The only major difference that sets apart the two is the ability of the investors to either invest or withdraw from the mutual fund schemes.

What exactly are open-ended mutual funds?

Open-ended mutual funds, as the name suggests, are a class of mutual funds that provide investors with the flexibility and luxury of investing or withdrawing from mutual funds at all times. These funds process the transactions placed by investors at the current NAV (net asset value) in their respective standard processing times. Therefore, open-ended mutual funds can be considered liquid as they allow investments and redemptions at all times. Most mutual fund schemes in the market are open-ended.

Investors do not have to worry about the lock-in period restrictions as these funds don't have one, and they don't have a maturity period as well. Furthermore, typically, open-ended funds are not bound to a maximum limit with respect to assets under management (AUM). The NAV of these fund plans is calculated at the end of each business day. These funds are not traded on any stock exchange.

What exactly are close-ended mutual funds?

As implied in their name, close-ended funds are mutual fund schemes that come with a window to invest and redeem investments. These funds either accept investments during a predetermined time frame or allow for redemptions after completing a set maturity period. The units purchased by the investors are locked in for a given duration or until the fund plan attains its maturity.

Under certain circumstances, the fund houses will make the close-ended funds open-ended post completing the lock-in period, or transfer the units to an open-ended plan. However, this is possible only after the investors give their consent to do so. Fixed Maturity Plans or FMPs are examples of close-ended mutual fund schemes.

Some mutual fund schemes are purposely made close-ended to instill a sense of stability in the fund plan and aid the fund manager to reap long-term benefits from investing in the underlying securities. Some open-ended funds may see abrupt redemption pressures from the investors, which will pressurise the fund manager to redeem investments from the underlying securities to meet the redemption request.

Who should consider investing in open-ended mutual funds?

Those investors that prefer liquidity over long-term benefits must consider investing in open-ended mutual fund schemes. Since these funds are not bound to a maturity period or lock-in period, it allows investors to enter or exit mutual funds at their comfort. However, the temptation to withdraw from these funds might be a disadvantage as it's easy to withdraw as there is no penalty on early withdrawals. Short-term investors may consider investing in these funds.

Who should consider investing in close-ended mutual funds?

If you are looking to invest for a long-time, you may consider investing in close-ended mutual funds. These funds are designed to help investors achieve their specific goals. For instance, ELSS mutual funds help investors claim a tax deduction of up to Rs 1,50,000 a year under Section 80C of the Income Tax Act, 1961, and save up to Rs 46,800 a year in taxes. However, investors must note that their investments will be locked in for the given duration, and there may not be provisions to withdraw before the expiry of the maturity period under any circumstance.

Differences Between Open-Ended and Close-Ended Mutual Funds

Factors to Consider While Choosing Between Open and Close-Ended Funds

As an investor, you must consider the following parameters while choosing to invest between close-ended and open-ended mutual funds:

• Entry time: Some close-ended funds are open to investments only during a predefined window. If you miss investing in this duration, you will not have access to the fund plan or will have to wait until the fund is open for investments, which may or may not happen. Open-ended funds accept investments and redemption requests at all times.
• Investment horizon: By investing your money in a close-ended mutual fund plan, you agree to the lock-in period norms. You are not allowed to withdraw your money under any circumstance. Therefore, it becomes extra crucial to know your investment horizon before investing in a close-ended fund plan. If you are not sure about your investment horizon and plan to withdraw your money in a short duration, you may opt to invest in an open-ended fund. However, you need to note that the best returns are obtained when the investment horizon is longer.
• Mode of investment: As already mentioned earlier, most close-ended mutual fund plans don’t accept the systematic investment plan (SIP) mode of investment. This means that you will not be able to reap the benefits of rupee cost averaging by investing in close-ended mutual fund plans. Close-ended mutual funds, like ELSS, that come with a lock-in period, will impose the lock-in on every investment made. For instance, when you invest in an ELSS mutual fund through an SIP in March 2022 through December 2022, then the investment made through each SIP is locked in for three years. The amount invested in March 2022 will be locked in until March 2025, April 2022 until April 2025, and so on. There are no such restrictions on open-ended mutual fund schemes.

Conclusion

Close-ended mutual funds and open-ended mutual funds come with their own set of pros and cons. As an investor, you must assess your requirements before deciding to invest in either of the two types of mutual fund schemes.