Open-Ended Fund: Definition, Example, Pros and Cons

What Is an Open-End Fund?

An open-end fund is a diversified portfolio of pooled investor money that can issue unlimited shares. The fund sponsor sells shares directly to investors and redeems them as well. These shares are priced daily based on their net asset value (NAV). Most mutual and exchange-traded funds (ETFs) are open-end.

They are also more common than their counterpart, closed-end funds, and are the bulk of the investment options in company-sponsored retirement plans, such as 401(k) plans.

How an Open-End Fund Works

An open-end fund issues shares if buyers want them. It's always open to investment. Purchasing shares causes the fund to create new—replacement—shares, while selling shares takes them out of circulation. Shares are bought and sold on demand at their NAV. The daily basis of the net asset value is on the value of the fund’s underlying securities and is calculated at the end of the trading day for mutual funds. If a large number of shares are redeemed, the fund may sell some of its investments to pay the selling investors.

An open-end fund provides investors with an easy, low-cost way to pool money and buy a diversified portfolio. Investment goals for open-end funds include holding growth, income, large-cap, and small-cap stocks, among many others. The funds can target specific industries or countries. Investors typically do not need a lot of money to gain entry into an open-end fund.

Occasionally, when a fund's investment management determines that its total assets have become too large for its goals, the fund is closed to new investors. In rare cases, the fund's investors instigate the move to be a closed-end fund.

Open-end funds are so familiar—virtually synonymous with mutual funds—that many investors may not realize they are not the only type of fund in town. That's because most mutual funds and ETFs are open-end, though pooled investments were historically closed-end until the 1970s.

Difference From Closed-End Funds

Closed-end funds launch through an initial public offering and shares in them on exchanges. They price trades at a discount or premium to the NAV based on supply and demand throughout the trading day.

Closed-end funds cost more at times, given wider bid-ask spreads for illiquid funds. Occasional volatility means their price could be higher or lower than its NAV would indicate. Closed-end fund shares must be traded through a broker.

Pros and Cons of Open-End Funds

Both open- and closed-end funds are run by portfolio managers with the help of analysts. Both types of funds mitigate security-specific risk by holding diversified investments and having lower investment and operating costs because of the pooling of investor funds.

Open-end funds must maintain ample cash reserves to meet shareholder redemptions. Since these funds must be kept in reserve and not invested, their yields can be lower, all else being equal. Open-end funds typically provide more security, while closed-end funds offer a bigger return.

Because management must continually adjust holdings to meet investor demand, the fees for these funds can be higher than those for other funds. Investors in open-end funds enjoy greater flexibility in buying and selling shares since the sponsoring fund family always makes a market in them.

Real World Example of an Open-End Fund

Fidelity's Magellan Fund, one of the investment company's earliest open-end funds, aims at capital appreciation. It was founded in 1963, and during the late 1970s and 1980s, it became legendary for regularly beating the stock market. As of the beginning of the second quarter of 2024, it had a lifetime average annual total return of 15.8%.

Its portfolio manager, Peter Lynch, became a household name. The fund became so popular, with assets hitting $100 billion, that in 1997, Fidelity closed it to new investors for nearly a decade. It reopened in 2008.

The Bottom Line

Open-end funds are a popular choice for investors seeking diversification and flexibility. They allow for unlimited shares and are priced in relation to the NAV. The NAV is calculated only at the close of trading each day for open-end mutual funds. While they offer significant advantages such as liquidity and a wide range of investment options, potential drawbacks include management fees and the impact of redemptions on the fund's performance.