A chit fund is a revolving savings scheme that has been a part of the Indian financial system for over a century. It is also known as chit, chitty, or kuree. A chit fund is an excellent financial tool for both saving and borrowing. As a savings vehicle, it provides a good return on investment, and as a loan scheme, it can be a reliable source of funds in case of emergency or otherwise.
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What is a Chit Fund?
A Chit Fund is a financial instrument that is a combination of savings and loans. It has been part of the Indian financial system for over a century. At its most basic level, in a chit fund, a group of people or subscribers agree to contribute a fixed amount every month for a fixed period of time to a corpus. This amount is auctioned to the lowest bidder, and the remaining funds are distributed equally among the remaining members as a dividend after deducting the organizer’s commission.
This can be best understood with an example: if we start a chit fund scheme with 20 members each paying a monthly instalment of INR 5000, the first month’s corpus will be INR 1,00,000.
How do chit funds work?
In a chit fund scheme, a group of people regularly contribute to the chip’s value for a period equal to the number of investors (members or subscribers). The amount collected is given to a person who is either selected through a lucky draw (lottery system) or an auction.
In the auction allocation system, the person who offers the lowest bid (agrees to apply the lowest amount) gets the money. This type of auction system is known as a “reverse auction. The amount dropped by the winning bidder is then split equally among the other members after deducting the master’s commission and other fees. The amount each member receives is called a dividend. Even after recovering the amount, the winning bidder must continue to invest.
Types of chit fund
- State-run Chit Funds: This category includes mutual funds that are run by state governments. Since the state runs these funds, the chances of losses are minimal and business processes are transparent. Mysore Sales International Limited (MSIL) and Kerala State Financial Enterprises (KSFE) are examples of state chit funds.
- Registered Chit Funds: These are privately run Chit Funds, registered with the Registrar of Chits and regulated by the State Governments as per Reserve Bank of India guidelines under the Chit Fund Act, 1982. These funds are considered safe as they are regulated by a legal framework, and therefore the risk is fully covered.
- Unregistered Chit Funds: These types of chit funds are run by groups of friends, relatives, peers, or colleagues. Investing in unregistered funds is considered risky because they are not subject to any law. Despite the personal risk involved in participating in an unregistered investment fund, these funds are widespread in India as they are usually formed by close groups of associates, and usually, all the participants know each other.
Features of chit fund
Here are 6 features of chit funds that you must know before investing
- They are credit and savings schemes combined into one.
- It acts as a microfinance institution.
- They have a predetermined value and duration.
- They allow you to borrow at a lower interest rate than loan sharks.
- They are best suited to meet the financial requirements of people from lower-income households.
- All subscribers’ deposits are converted into a lump sum.
Benefits of chit fund
- Chit funds are a savings and investment tool that allows you to save as well as borrow.
- Quick access to money: It’s easy to join the chip fund scheme, and you can borrow a lump sum (pot) just by paying the first instalment.
- No or Little Paperwork: It is a great product that fulfils people’s financial needs without having to provide documents such as IT returns, PAN cards, etc.
- No Collateral: Unlike banks and other financial institutions that require tangible collateral, a money fund is provided on the basis of personal guarantees.
- No questions asked: You don’t have to disclose the purpose of using the borrowed money (pot).
- Emergency cash: You can easily access money to cover unexpected expenses or financial emergencies.
Things to consider before investing in a chit fund
- Make sure your chit fund is a registered company.
- Check the extract from the company’s commercial register.
- Find out who is the promoter of the chit fund company. Make sure they are all financially sound.
- Check the registration number and certificate issued by the registrar of mutual funds of the state in which the mutual fund company operates.
- Find out what commission the master takes. Choose the chit fund company with the lowest commission.
- Check with the office of the chit fund registrar if there are any complaints or pending lawsuits against the chit fund company.
- Make sure you are financially prepared to contribute throughout the chit-fund cycle.
Investing in a registered chit fund is a good financial decision for investors as their maturity period is usually short and the amount subscribed is small, so they are easily accessible. The investment can be designed to suit individual needs. Paying regular instalments will help you bring discipline to your finances and can be a reliable source of funds in case of an emergency.