I was looking at putting in a portion of my money in a chit fund. Wanted to know if it is a prudent decision, because I’ve heard many instances where they have come in very handy to meet short term capital needs.
Chit firm closed, 3 arrested for duping depositors of Rs 2 crore - TOI
Headlines like these are a pretty common sight.
Chit funds are one of the most popular avenues of saving and borrowing in India. They are especially popular among the financially illiterate, housewives, small business, shops and establishments.
While the size of the regulated segment is about Rs.35,000 crores it is estimated that the size of unregulated chit funds is 100 times that. Chit funds run on trust and the fact that there is almost no documentation involved makes it easier for investors to get started. For borrowers that draw here is that no collateral is required.
Even though chit funds fall under the ambit of The Chit Fund Act, 1982, a vast majority of chit funds are run by unregistered entities and if they go bust investors are left with little or no recourse.
How does a chit fund work?
Let’s say there is a group of 50 people who are putting in Rs.3000 PM for 48 months. This works out to Rs.150000 per month. Members who want to borrow the money will be allowed to bid on the pot. Member bid based on the discount they are willing to take based on the value of the pot. There is no baseline but members who are desperate take a higher discount.
So let’s say the winning bidder is offering a discount of 30%. He will get Rs.105000. The remaining Rs.45000 minus a discount of say 5% off will be paid out as a dividend to the remaining members. The 5% goes to the agent for running the fund.
As you can see this is not really a prudent way of investing or borrowing. This investing part in a chit fund is all about receiving dividends. But if a person invests in a fund where people aren’t offering higher discounts to borrow then the returns will be subpar. People borrowing from a chit fund also get a raw deal in terms of interest rates and they most often than not end up paying in the higher double digits.
Risks
There is no bigger risk than that of the fund going bust. Since most of these funds are unorganized, the investor loses his entire investment if the fund goes bust. You would have seen innumerable stories on the news channels and papers about people running from pillar to post in the hopes of recovering their money.
According to a survey by IFMR, these were the reasons why people chose to invest in chit funds.
Almost all of the reason why investors choose chit funds are misguided at best. There are far better and safer alternatives be it investing or for borrowing.
Considering that financial education in India is almost non-existent it is not surprising that a vast majority of Indians invest in chit funds. Given the risks and the huge variation in the returns, it is highly inadvisable for people to invest in chits funds. There are safer alternatives such as debt funds that conservative investors can go for.
10 Likes
my father is putting money in chit funds for decades…
thing is the investment circle is reliable and this is for business people
My grandfather (80 years) is a chain smoker with minimum 15 cigarettes a day he smokes and can defeat a 20 years old boy with his left hand. Thing is the lungs have to be very strong and this for the people who has very strong heart.
whether your grandpa smokes from the comission he gets from chit funds 
reality is chit funds are there everwhere likw pawn shops … its unorganized but thats the reality
Simple answer NO.
No my grandpa is not as lucky as your father 
. Your father is an exception, I wish everybody’s father should be like yours.
you sound like you lost some money in chit fund 
i am not endorsing chit fund … but if the circle is good and reliable it’s good…
in my native chits are quite popular among small business people …
this is as popular as micro finance and it got regulated only recently …
reality is it’s huge and if you don’t like it doesn’t mean it is not the reality
Chits funds are very common in Kerala. Kerala govt itself is running them through KSFE outlets.
in my place chit funds are semi regulated …
usually the chit fund organizers are decent sized firm with good firms or local micro finance companies …
one of the popular chit fund organizers in erode is also the most popular micro finance …
i don’t know about other places , there are chances that auctioneers can cheat the chit fund organizers than the reverse …
i feel chit fund organizers are getting cool money … like if the chit fund is 10L , in every auction they get cool 30 to 50k as organizing fee…