Money management is an essential aspect of life. Many people wish to invest their money. Many people in India do not yet participate in the organized financial sector. Because they are not eligible for a bank account or do not have the necessary documentation, a lot of people in the lower income bracket choose to invest in chit funds. Investments in chit funds are not always undesirable. Because it has been used to defraud naive investors in the past, it has a bad reputation. Chit funds that are registered and run by the government are safe places to invest. Recurring deposits, on the other hand, are a much safer investment. At the end of the tenure, the returns are fixed and guaranteed. However, the two ventures have their upsides and downsides. Let’s look at how the two choices differ from one another.
Chit fund is a financial investment platform in which small deposits are used to generate high returns on the promise that these investments will increase in value. These types of investments are often referred to as “mutual funds” because they pool capital from multiple investors and use it to invest in different types of securities, such as stocks, bonds, or commodities. Chit funds typically charge a management fee or a commission for the services provided by the underlying fund managers. These fees generally range from 0.5% to 5% of the total value of the fund. However, chit funds can also offer high returns due to the potential for gains in the underlying securities due to market movements or other factors.
What is Chit Fund ?
A financial instrument that combines borrowings and savings is called a chit fund. For more than a century, it has been a part of India’s financial system. The most fundamental aspect of a chit fund is that a group of subscribers agrees to make a predetermined monthly contribution to a corpus for a predetermined amount of time. After deducting the organizer’s commission, this amount is auctioned to the lowest bidder, and the remainder is divided equally among the remaining members as a dividend.
At the time of the auction, the member with the highest bid wins the amount known as prize money. Therefore, the winner will receive a prize of INR 75,000 if the maximum discount is INR 25,000. After deducting the organizer’s fee, which is typically 5% of the chit value, or INR 5,000, the discount amount of INR 20,000 is divided equally among all 20 members. The chit fund serves as a borrowing scheme for the winner, while the remaining members receive returns on their invested funds (in this case, INR 1,000).
How Chit Funds Work?
We’ll look at an example for chit funds. Let’s say a chit fund is established by a group of ten people. For a period of ten months, each one of them will pay Rs. of months equals no of the fund’s members). There will be a single organizer in this group who will handle all of the meetings, auctions, and other events. He will charge some organizers.
Now, for the first month, each of the ten people gets together and gives Rs. 1000 each. There is currently a total of Rs. 10,000 available. Let’s say three bidders compete for this sum. The bid by Person A is Rs. 9000, and Person B offers Rs. 7000, while Person C offers Rs. 8000. Person B wins the sum of Rs. 7000 because their bid was the lowest. Additionally, he will be charged an organizer fee of approximately Rs. 5 percent. 500. He receives Rs back in full. 6500. The profit, or the remaining 3,000, will be divided equally among all ten people. Each individual receives Rs. 300. A new bidder submits one each month, and the process continues for ten months.
What are the Different Types of Chit Funds?
Chit funds are a type of financial scheme in which individuals or companies contribute money to a mutual fund with the expectation of receiving returns based on the performance of that fund’s investments. There are several different types of chit funds, each with its own unique features and benefits. Some of the most common types of chit funds include variable-expense chit funds and fixed-expense chit funds. Variable-expense chit funds charge different fees for different levels of investment risk, while fixed-expense chit funds charge a set fee regardless of how much you invest.
Additionally, there are annuity chit funds, which provide regular payments based on an individual’s age or the performance of the fund, as well as unit-liability chit funds, which allow individuals to withdraw their contributions at any time without incurring any losses. Chit funds can be an excellent way to diversify your investment portfolio and make regular income while reducing your risk.
There are five different kinds of chit funds. Before making a decision about an investment, you need to be familiar with each one.
1. Special Purpose Chit Funds
These funds work for a specific purpose. For instance, several men can form a group to start a savings scheme for Christmas cakes. The end date of such a fund will usually be one week before Christmas.
The group will use the collected amount to make cakes in bulk. After that, cakes will be distributed to the members at Christmas. Hence, special purpose chit funds minimise the efforts and expenses.
2. Organised Chit Funds
These funds are more prominent in North India, where members need to meet weekly or monthly. Small slips of papers with the subscribers’ names are collected in a box. The group’s person-in-charge chooses a paper slip from the box in front of the members.
A person whose name gets selected receives the entire fund. Then, that name gets eliminated from the box. The winner’s name will not be picked up again in the next meeting. However, he/she will be present there ─ contributing his/her share of money.
3. Online Chit Funds
In this digital era, chit funds have been upgraded and are even available online. These kinds of funds organise online auctions. Furthermore, monthly contributions of the bidders and the prize money payment are made through online mode. Each member must have an online account to circulate and manage chit funds.
4. Registered Chit Funds
The Registrar of Firms, Societies and Chits offers registration to these chit funds. The Reserve Bank of India regulates such funds by enforcing the Chit Fund Act, 1982 throughout India.
5. Unregistered Chit Funds
Colleagues, family or friends organise these funds, which act as savings schemes. They are riskier as compared to registered chit funds.
What are the Features of Chit Funds?
Here are the major features of chit funds you ought to know before investing in them!
- Deposits from all the members lead to the accumulation of a lump sum amount.
- They serve as a means of financial assistance for lower-income households.
- These funds offer you a lower interest rate than moneylenders.
- They come with a predefined value and duration.
- Such funds work as micro-finance institutions.
- They are a combination of savings and credit schemes.
What are the Benefits of Chit Funds?
Chit funds are a unique form of mutual fund that allows users to invest small amounts of money in a variety of stocks, bonds, and other financial assets. These funds are typically managed by a third-party custodian, who manages the investments in accordance with specific investment guidelines set by the fund’s sponsor. Users can expect to earn high returns as the value of their investments grow over time, thanks to the diversification and risk management offered by chit funds.
Chit funds are an excellent way to build wealth and diversify one’s portfolio without having to manage individual investments manually. Additionally, chit funds are often free or low cost to use, making them a great option for investors on a budget. With so many benefits, it is no wonder that chit funds are rapidly gaining popularity among investors worldwide.
Chit funds can be beneficial to you in the following ways:
1. Multiple Usages
These funds can be used for a variety of things, like the education of your children, attending festivals, religious ceremonies, paying for medical bills, traveling, shopping, and getting married.
Bidders determine the rate of interest mutually; it differs from auction to auction. Besides, chit funds keep lower interest rates for borrowers as compared to other financiers.
3. High Dividend
Investors receive a comparatively higher dividend than interests earned on the savings in multiple deposit schemes.
4. Urgent Cash
You can access instant cash during a financial emergency or meet a sudden expense. You also have the chance to borrow the pot (lump sum amount) after paying your first instalment.
5. No Queries
An applicant does not need to disclose why he/she is getting the money.
You can get cash without promising any resource as guarantee. It will just rely upon individual guarantees, dissimilar to NBFCs and banks that require substantial security.
7. Less Or No Paperwork
It meets the financial requirements of the people without asking for details such as a PAN card and IT returns.
Things to Consider Before Investing in a Chit Fund
Chit Funds are a great way to invest your money without having to deal with the hassles and risks of trading stocks, bonds, and other securities. Chit funds are essentially mutual funds made up of small amounts of money from many investors. The returns on a chit fund are typically higher than those offered by traditional mutual funds because there is greater risk-sharing among the fund’s investors. This means that if one investor’s investment loses value, another’s may gain, resulting in overall gains for the fund. Chit funds also provide diversification benefits as each investor’s stake in the fund is different from every other investor’s.
Listed below are some of the things you need to consider before putting your money in a chit fund:
- You must ensure that the chit fund is a registered company. You can approach the registrar of the companies to verify their certificate of incorporation.
- Do not forget to check the registration number along with certificates issued by the registrar of the state in which the chit fund company operates.
- Do not forget to find out details about the people running the chit fund. Checking their financial health is more important than you think.
- You can compare various chit funds based on the foreman’s commission. Consider choosing a chit fund with the lowest commission as it would be a wise decision.
- Before investing in a chit fund, make sure you have the finances to continue contributing throughout the chit fund cycle.
- Check whether there are any court cases pending against the chit fund company at the office of the Registrar of Chits of the respective State Government.
Investing in a chit fund can be a fruitful option as its subscription amount is low and the maturity period is primarily short. Furthermore, they design investments to satisfy individual needs. You can effectively manage your finances through regular instalment payments.