Before understanding the structure of mutual funds, let us get a quick introduction.
Mutual funds are investment tools for people from the non financial background in order to aid them in their investment in the securities markets.
These funds are managed by Asset Management Company on behalf of the investors. Mutual funds indirectly invest the investors money in equity, debt, government bonds and commodities in order to provide better returns for their investors.
There are different types of mutual funds and the investor needs to thoroughly understand the investment these objectives before investing. One such classification of mutual funds can be based on the structure of mutual funds.
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Three basic structure of mutual funds
Mutual funds are divided into 3 basic structures
- Open ended funds
- Close ended funds
- Exchange traded funds
Let us understand the objectives of each structure of mutual funds in detail.
Open ended funds
Open ended mutual funds are funds that allow the investor to enter or exit the investment scheme in any given point of time. These mutual funds may come with a lock in period, which means that there is on obligation to stay invested in a said duration. It is the will of the investor whether to stay investor to exit at any given point of time.
As the words suggests ‘open ended’, which means there is no restriction on the entry / exit for the investors in participate in these fund scheme.
Some examples of open ended funds:
- Equity mutual funds
- Debt mutual funds
- Short duration funds
- Arbitrage funds
Advantages of open ended funds
One of the greatest advantage of open ended funds is that it allows the investors to enter or exit a particular fund in any given point of time. These funds do come with a lock in period, but it does not put an obligation on the investor to freeze the assets.
Another advantage is that it allows the investors get an opportunity to time the market. This means that investors can enter the funds at lows and exit at highs, thereby making a suitable short term gain. The short term for mutual funds investment is usually regarded as minimum one year period.
Close ended funds
Close ended mutual funds are special funds that allow the entry and exit of investors only in a specific duration of time. Hence, the investors in the case does not have a direct control over the buying / selling period of the mutual funds.
They are great for investors to maintain the financial discipline. As there is an obligation to stay invested, the investor will not be tempted to liquidate the funds in case of emergency. This will result in getting returns for the investor from the effect of compounding.
Close ended funds come with a target object for the investors. The examples below will explain how these funds can help in meeting financial objectives of people.
Examples of close ended funds
ELSS (Equity Linked Saving Scheme)
ELSS funds are a sort of closed-end fund that allows investors to invest at any time, but restricts their ability to exit the fund. These funds are tax-advantaged investment vehicles that allow investors to save money on their taxes in exchange for a lock in period.
ELSS mutual fund come with a lock in period of 3 – 5 years, making the asset freeze for the said duration. Since they cannot be liquidated by the investor, they are a type of close ended funds.
Retirement funds are invested with an objective to serve the investor in the time of retirement. Thus, in order to maintain the importance of these funds, they come with a lock in period.
The lock in period acts like a external pressure to avoid the use of the funds before the investors retirement. Thus, one needs to thoroughly have an investment plan and invest wisely in these funds.
Children advantage fund
These funds come with a purpose to help parents save for their children’s future education. The parents have an option to start their investment in the name of their child so that he/she can access those funds when he/she turns 18 years.
Exchange traded funds
Exchange-traded funds (ETFs) are a type of mutual fund that is exchanged in real time on the stock market. Exchange traded funds, unlike other mutual funds, may be bought and sold exactly like stocks. Because these units are exchanged in real time, their price will be also impacted by mutual fund unit demand and supply.
Advantages of Exchange Traded Funds
Exchange traded funds allow the investors to trade in mutual funds in real time. The NAV (Net Asset Value) reflecting on the fund on the day of investment will be the same as the day purchased.
ETFs also have a low expense ratio as they are passive funds and not directly managed by a fund manager.
Each of these structure of mutual funds comes with an objective of investment. Thus, one needs to identify the right investment vehicle before planning your investment. Please consult your financial advisor before taking part in such investment tools.