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Much like an individual’s wardrobe, many portfolios are collections of separate items. They combine stocks and bonds and other investments into the investor’s desired “look.” Open- and closed-end funds offer this kind of variety and opportunity in one product.

Mutual funds are open-end funds – there’s no limit to the shares they can issue. When an investor buys shares in a mutual fund, more shares are created. When shares are sold, they’re removed from circulation. If too many are redeemed at the same time, the fund may have to sell some of its investments to pay the investor.

Mutual funds do not trade on the open market. Their price is based on the fund’s total value, or net asset value, which is reset at the end of each day based on the amount of shares bought and sold during that time.

Closed-end funds are launched through an IPO, and trade in the market like a stock or an ETF. They issue a limited amount of shares. Their value is also based on their NAV, but supply and demand determine the prices at which they trade.

Investors should know that many closed-end funds pay nice dividends, and some use leverage to increase gains. But with the chance for big returns comes intense scrutiny, and many closed-end funds end up being downgraded. Downgrades make it more expensive for closed-end funds to borrow money to invest, and higher borrowing costs can ultimately reduce returns.

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