Buying Closed-End Funds

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Buying Closed-End Funds

Because closed-end fund shares are sold on the secondary market, you will need to go through a broker to purchase shares. In exchange for making the trade for you, brokers will charge you a commission. The commission is usually based on the total number of shares bought or sold.

The types of brokers available

There are three types of brokers you can buy from: full-service, discount, and deep-discount. A full-service broker will conduct research and provide investment advice, and therefore charge higher commissions. You will pay much less in commission fees with a discount broker, but you will not get the investment advice without an additional fee. Buying at a deep discount will get you the basic transaction, but that is about all. Keep in mind that close-end mutual funds do not provide a prospectus for shares traded on the secondary market. This means you must do your own research or rely upon advice provided by your broker or investment advisor.

What types of accounts are available?

Once you decide on a broker, you open up either a cash or a margin account. In a cash account, you pay for your shares in cash. A margin account is more flexible. You can use the securities in your account as collateral to buy more discount shares with the same amount of money. This is known as leveraging. You will have to pay interest on the money you borrow from your broker.

You can also use your margin account to borrow shares and sell them with the agreement to buy them back later. This is called selling short. If you sell them at a higher price than you buy them back for, you make a profit. Selling short is used when an investor believes the market price of the closed-end funds will decline.

Because of special risks and complexities associated with the use of leverage, as well as short selling, the use of margin may not be suitable for many investors. Before opening a margin account, you should familiarize yourself with these special risks.

Placing orders: the two types

There are two types of orders you can place with your broker to buy closed-end fund shares. To buy your shares at the next available market price, you place a market order. If you are willing to buy only at a specific price or better, you place a limit order.

Closed-end funds trade on the secondary market and therefore must be purchased through a broker unless they are being offered for the first time. An initial offering of a closed-end fund is made only with a prospectus and priced according to the prospectus. All other transaction follow the same procedures as buying and selling stock and other securities.