Making investments in chit funds

Chit funds are among the most popular savings schemes in the country, but it is important to ascertain if their terms suit everyone

Chit funds are a kind of savings cum borrowing scheme. “Chit” means a transaction under which a person enters into an agreement with a specified number of persons that each one of them shall subscribe a certain sum of money (or a certain quantity of grain instead) by way of periodic instalments over a definite period and that each such subscriber shall, in his or her turn, as determined by lot or by auction or by tender or in such other manner as may be specified in the chit agreement, be entitled to the prize amount. Chit is called by several names such as chit fund, chitty, and kuri.

In simple words, a chit fund is an arrangement, wherein a group of people come together to pool a fixed amount at regular intervals for a fixed time period.

There are basically two parties at work in chit funds: a) Subscribers/members: People who contribute money for either the purpose of savings, or for borrowing the pool. b) Foreman: Person/company that conducts the chit and is responsible for bringing members together, collecting the money from them, presiding over auctions, and keeping records. He also gets a fixed compensation (generally 5% of the pooled amount) for his efforts.
In a Chit Fund, the number of members/subscribers is always equal to the number of times the contribution is to be made to ensure every member gets a turn. Once the money is collected, any of the ‘needy’ members can bid for an auction. The member who has quoted the highest discount will get the money. This discount is then distributed among other members as dividend.

Now the question is, should you invest in a chit fund? Here are a few points to consider before investing in chit funds:

Invest in registered chit funds
The Chit Fund Act, 1982, has been framed by the government to regulate and control chit fund operations. There are also number of state chit fund acts. There is an office of Registrar of Chit Funds in every state that monitors chit funds operations. There is an exhaustive list of registered chit funds on the website of the Ministry of Corporate Affairs. Since the chit fund needs to deposit 100% value of the ‘pot’ with the Registrar of Chit Funds prior to commencement of the chit scheme, small funds do not register themselves as they will have to forgo the auction for the first month. It is always advisable to go for chit funds that are registered.

Consider the other risks involved
There are other risks involved with chit funds investment. There is risk of a prized member not paying his remaining installments after winning the bid. Then the delay in installments by other members can also hinder the operations of the chit funds. So it is important to access information about the paying capacity of the members before getting yourself attached to a chit fund. It is better if you know the people you are starting your chit fund with.

Discipline in investment
Chit funds require you to invest a fixed amount every month. You need to be able to maintain the monthly investment, otherwise the chit fund organisers charge interest and levy penalty on late payment or default in payment. Hence, you should understand your long-term commitment and only start.

No fixed returns
You cannot calculate the returns in chit funds as they depend on the auction bid which takes place every month. If you want assured returns you should explore other financial instruments such as FDs etc.

Getting funds in emergency
Some people say that chit funds are best when it comes to receiving funds in emergency. It is true to some point, but if you come to think of this, it might be a loss-making proposition. Assuming there are three to four members who need the money that month, then to get that amount , you really need to give more discount i.e. lower your bid which will reduce your actual return on the chit fund.

You should thoroughly analyse the pros and cons of investing in chit funds. Only if they suit your needs, should you take them, otherwise there are other options available for investments and with better returns too.

(The writer is Managing Director of Sinhasi Consultants)