Still in college? Here's how you can invest in mutual funds with your pocket money

Not earning yet? You can still invest! Even if you’re managing your college hustles on a budget, you can start building your wealth with just a little from your pocket money. Although there are no specific schemes designed exclusively for students, the Securities and Exchange Board of India ( SEBI ) lists over 1,500 mutual fund schemes. With a few tips, students can navigate through these choices to select mutual funds for long-term growth.

What are mutual funds?

Mutual funds are essentially collective investment schemes where multiple investors pool their money, which is then managed by financial professionals. These experts allocate the pooled funds across various assets, including stocks and bonds, with the objective of generating returns over time.

Types of mutual funds

Open-Ended vs Closed-Ended Funds

A fundamental distinction in mutual funds lies between open-ended and closed-ended funds. Open-ended funds offer investors flexibility, allowing them to buy or sell their investments at any time. This is particularly advantageous for students who may require quick access to funds for emergencies or daily expenses. Conversely, closed-ended funds restrict access to investments for a predetermined period, making them less suitable for students needing liquidity.

"When it comes to mutual funds, open-ended funds are particularly advantageous for students. They provide the flexibility to buy or sell investments at any time, ensuring easy access to funds for emergencies or unexpected expenses. This liquidity is crucial for students, who may not have the financial stability to lock their money away for extended periods, as seen with closed-ended funds," said Ravi Singh, SVP - Retail Research at Religare Broking.

Direct Plans vs Regular Plans

Investors must also choose between direct and regular plans. Direct plans involve investing directly with the mutual fund company, eliminating intermediaries and resulting in lower fees. This leads to potentially higher returns over time. Regular plans, which involve brokers or financial advisors, can provide guidance for new investors but come with higher costs due to commissions. Students comfortable conducting their own research may benefit from opting for direct plans.

Equity vs Debt Mutual Funds

Another important choice involves selecting between equity and debt mutual funds. Equity funds focus on stocks and are designed for capital appreciation, offering potentially higher returns at a higher risk. Debt mutual funds, on the other hand, invest in fixed-income securities such as bonds, providing steadier, more moderate returns. Given their typically smaller investment amounts, students should be cautious about over-diversifying their portfolios, as spreading investments too thinly can dilute potential returns.

Growth vs Dividend Options

When exploring mutual funds, investors may encounter options for growth and dividend funds. Growth funds reinvest profits, allowing money to compound over time, which is ideal for young investors seeking long-term wealth accumulation. In contrast, dividend funds provide regular payouts, which may appeal for immediate income but can hinder overall growth since profits are not reinvested.

"Given that students typically have a higher risk tolerance and are not in immediate need of income, growth funds can enhance wealth accumulation over time. Unlike dividend funds, which provide regular payouts but may limit overall growth, growth funds align well with students’ future financial goals, such as funding higher education or starting a career," Singh added.

Small-Cap vs Large-Cap Funds

Investors may also wonder about the performance differences between large-cap and small-cap mutual funds. Large-cap funds typically invest in well-established companies with a market capitalisation exceeding Rs 20,000 crore, which are generally more stable and less risky. Small-cap funds, on the other hand, focus on smaller companies with market capitalisations up to Rs 5,000 crore.

"Students have the luxury of time on their side and a higher risk appetite, making small-cap funds an attractive option for those looking to seize significant rewards despite the inherent risks," said Arpit Suri, CA & personal finance expert.

Top 5 small cap equity funds

As of September 30, 2024, the Invesco India Smallcap Fund has the highest one-year return amongst small-cap equity funds at 61.4 per cent, categorised as very high risk, according to data from Groww.

The Quant Small Cap Fund follows with a return of 56.9 per cent, also classified as very high risk. The Tata Small Cap Fund reports a return of 52.2 per cent, maintaining its very high-risk designation.

The Bank of India Small Cap Fund achieved a return of 52.0 per cent, similarly categorised as very high risk. Lastly, the Nippon India Small Cap Fund has a one-year return of 50.2 per cent, which is also classified as very high risk.