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Collin Harness


Investing in Closed-End Funds

    1. What is a Closed-End Fund?

    A Closed-End Fund is a mutual fund that raises money by issuing shares via an IPO. The shares are sold in order to raise funds for the investments that will sit in the fund. The shares can be traded on the open stock market. Because it is closed no new shares will be issued to raise new money in the fund in the future.

    Open-Ended Funds like ETFs accept new inflows of money and are able to issue new shares and buyback shares.

    2. How do they work?

    They issue shares to raise money and then buy investments that generate revenue. Similar to a REIT they must pay out their returns to shareholder owners.

    3. Why would someone buy a Closed-End Fund?

    These funds pay out their revenue to shareholder owners.

    4. CEF Taxes and Your Taxes

    Closed-End Funds maintain tax free status. But in order to maintain this status they must pay out earnings to shareholders. This is where the government makes its tax revenue the person that receives the income must pay tax on that income.

    Unlike dividends which are taxed at a lower rate, income from CEFs is generally considered ordinary income.

    Meaning that the government treats this income as the same as if you earned it from a job.

    You have to pay ordinary income tax on this income which is higher than dividend tax rates.

    The more income you receive the higher you tax bracket could be.

    5. CEF trading strategy?

    CEFs trade like stocks on the open market. Their share price fluctuates based on demand.

    But it does always correlate to the value of the assets within the fund. Sometimes the share price of the fund is lower than the value of the assets in the fund.

    As an investor you could find different funds that are below their NAV: Net Asset Value. Because you are buying into a fund at a discount.

    6. Debt

    CEFs are allowed to leverage the assets within the fund for greater returns. But leverage can also damage the fund if it goes south.

    7. Management

    The fund manager does take a fee for running the fund.

    Make sure you look at the expense ratio and see if the manager is making too much money. Avoid those.

    8. Underlying assets

    What is the CEF invested into?

    You want to make sure the investments are sound and growing.

    Bad investment assets could endanger the fund and its cash payout.

    9. Liquid or illiquid

    The shares of CEFs are traded on the market and fairly liquid, meaning that you can buy or sell your shares fairly easily.

    But the investments within the CEF are generally stable like bonds. They need to be in order for the CEF to have consistent steady returns.

    10. Avoid those taxes?

    Invest into a CEF via a ROTH IRA

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