Based on their structure and characteristics, mutual funds can be broadly classified into two types - an open-ended mutual fund or a close-ended mutual fund. In this article, we’re going to take an in-depth look at the most common kind of mutual funds - open-ended mutual funds. Let’s begin.
What is an open-ended mutual fund?
A mutual fund scheme that has no limit on the number of units and has no fixed maturity is termed an open-ended mutual fund. The units of such a fund are available for purchase at all times. New units are created and issued as and when investors subscribe to an open-ended mutual fund.
One of the primary characteristics of such a mutual fund is that the units are directly purchased from and sold to the fund house issuing the fund at the prevailing Net Asset Value (NAV). The fund house is responsible for calculating and publishing the Net Asset Value (NAV) per unit of an open-ended fund. This is usually done after every trading session comes to a close.
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What are the advantages of an open-ended mutual fund?
Now that you’ve understood the meaning of an open-ended mutual fund, let’s proceed to take a look at some of its benefits.
1. High Liquidity
Liquidity is one of the major advantages of this type of mutual fund. Except for niche funds like the Equity Linked Savings Scheme (ELSS), all other open-ended funds don’t feature any lock-in period. This effectively means that you can buy and sell any number of units of the fund at any point in time.
2. Multiple Investment and Withdrawal Options
Another huge benefit of open-ended funds is that they are extremely flexible when it comes to investment and withdrawal options. In the case of investment, you can invest either a lump sum amount into the fund or opt for a Systematic Investment Plan (SIP), where you’re required to invest a certain sum regularly till the end of a chosen tenure.
Similarly, open-ended funds also give you the option to withdraw your investment systematically. Through a Systematic Withdrawal Plan (SWP), you can choose to withdraw a certain number of units regularly for a specific period. This allows you to receive a regular stream of income, which you can use to take care of your expenses.
Open-ended mutual funds also offer the benefit of Systematic Transfer Plans (STPs), where you can choose to transfer a certain number of units from one type of open-ended fund to another. For instance, you could choose to transfer 100 units each month from an equity fund to a debt fund or vice versa.
3. Easy Availability of Information
Unlike a close-ended mutual fund, there’s simply no dearth of information regarding the past performance or track record of open-ended mutual funds. The existence of such information across different market cycles and time periods allows you to better gauge the future growth potential of the fund and make an informed purchase decision. However, you should keep in mind that past performance or track record is not indicative of future market performance.
4. Tax Benefits
Equity Linked Savings Scheme (ELSS) is a special type of open-ended fund that offers tax benefits to investors. The investments that you make in an ELSS can be claimed by you as a deduction from your total taxable income under section 80C of the Income Tax Act, 1961. The maximum amount of investment that you can claim is limited to Rs. 1.5 lakhs per financial year.
What are the risks of an open-ended mutual fund?
No investment option is free from risk. This includes open-ended mutual funds as well. Here’s a quick look at some of the key risks surrounding these funds.
1. High Volatility
The NAV of an open-ended mutual fund is dependent on the movement of the market. So, if the market behaves in a volatile manner, the NAV of the fund would also be prone to it. Although the fund manager hopes to reduce the effect of market volatility through diversification, there’s always a certain degree of risk.
2. Prone to Significant Investments and Withdrawals
Since investors can subscribe to an open-ended fund at any point in time without any restrictions, the fund may see huge inflows or withdrawals. For instance, if a large number of investors sell their holdings in quick succession, there will be a huge outflow, which can have a negative effect on the fund.
3. Cash Flow Risk
If a large number of investors redeem their holdings at the same time, the fund manager may not be able to sell the units in the market to recover the funds of the investors. This is known as cash flow risk.
Conclusion
Open-ended mutual funds are among the most popular types of funds. The long list of advantages makes these funds a favourable investment option for investors. If you’re planning on investing in an open-ended fund, you need to first open a demat account in your name.
You can open a 2-in-1 trading and demat account online within a few minutes by simply filling out and submitting an application form on the Motilal Oswal website. So, what’re you waiting for? go ahead and get your demat account and start your investment journey today.