In addition to traditional mutual funds, you may often see the names of other types of funds thrown around. We won't go into too much detail, but here's the basic scoop on two of the most common terms.
Exchange-traded funds (ETFs)
Exchange traded funds are essentially mutual funds that trade like stocks. They've gained popularity in recent years, combining the ease of stock investing with two main advantages of mutual funds:
- Broad exposure: Wider index ETFs make it easy to buy the whole market, the biggest companies, the smallest, or any particular sector. If you don't feel like picking your own stocks, you can put your retirement money in an index that tracks the S&P 500 -- one of the most Foolish ways to save.
- Easy diversity: ETFs also provide a simple way to fill in the blanks of your portfolio. In addition to broad-market ETFs, more specialized variants are flourishing, each based on narrower, more sector-specific indexes. From bonds to real estate investment trusts to precious metals, if you can name it, there's probably an ETF for it.
Because ETFs are based on indexes, they can charge a lot less than actively managed funds, a savings that really adds up over time. But unlike many mutual funds, which let investors buy shares directly from the fund company with no commission fees, investors still have to pay brokerage fees to buy ETF shares, just as they would for a regular stock. Still, that gives ETF investors the flexibility to buy and sell shares whenever the market is open -- not just at the market's closing price, as most traditional mutual funds do.
Regular mutual funds are sometimes called open-end funds, because they allow investors to buy or sell shares at the fund's net asset value (NAV) directly from the fund company. When someone wants to buy, the fund company issues new shares; conversely, when someone wants to cash out, they sell those shares back to the fund company.
In contrast, closed-end funds have a limited number of shares, and they generally do not redeem or issue shares. When investors want to buy or sell their shares, they must go to the secondary market and find other investors willing to make a trade. This means that closed-end funds are essentially closed to new capital after the initial offering of their shares, freeing managers from accommodating any inflows or redemptions. While a closed-end fund can hold the same shares that open-end mutual funds do, its shares can be bought or sold at any time during the trading day, much like an ETF's.
Puzzlingly, closed-end funds often sell at a discount to their NAV. That can create bargains, but it also carries its own risk; you may wind up holding shares that are worth less the actual assets that back them.
Still not sure which of these investments is best for you? Check out our series on picking the right fund.