ETFs vs. CEFs: Confusion Remains

Recently on another site there was a discussion of the difference between exchange traded funds (ETFs) and closed-end funds (CEFs). A couple of years ago I was looking in to this matter myself. I knew they were different, but at the time I didn't know how.

Closed-end funds are similar to “traditional” mutual funds. In fact, they've been around for decades and were actually the first type of mutual fund. They hold baskets of stocks as you would expect. The key difference is that the price of a CEF share is not guaranteed to be equal to the underlying price of the individual company shares. This difference in price vs. the underlying value is referred to as a discount or a premium and it often ranges from -10% to +10% of the net asset value.

An ETF is also like a “traditional” mutual fund with shares that trade on an exchange just like stock from companies. This allows in-kind redemption by institutional investors. This activity results in there being no discount or premium for ETFs.

Be sure to check that you're not investing in a CEF if you're actually looking to buy into an ETF. Most investing sites make the distinction clear somewhere in the profile of any product. You just need to look for it. If a broker is pushing a particular CEF, be wary. They may be doing this because they make a commission on the sale. In most cases, there is an equivalent ETF that will achieve the same goals without the added negatives.

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