Investing in Chit Funds …First Understand How They Work

in Knowledge 0

Chit funds are not a cup of tea for many. Reason – they have never understood ‘what are chit funds and how exactly they work’. Pros and cons of investing in chit funds has always remained a matter of confusion for them. This article will serve those persons who want to learn many things about these funds.

What are Chit Funds?

A chit is a kind of arrangement whereby the members concerned agrees to contribute a fixed amount in periodical installments for a definite period of time. In return, each member will be entitled to prize money determined by way of lot/ bid/ tender. A chit is more or less like a savings scheme.

Example

Let us say that a chit consists of 25 members, who enter in to an agreement to subscribe Rs. 2,000 every month for next 25 months. There will be one organizer who will conduct the business of chit. The organizer is entitled to reward for taking the pains of managing the chit in the form of commission which is standard @ 5%.

Now every month, each member will contribute Rs. 2,000, i.e. the total amount of funds with the chit will be Rs. 50,000 for each month. From the first month itself, members will bid for the prize money depending upon their urgency of requirement for money. The one with the lowest bid will win. Suppose ‘A’ bids for Rs. 40,000 which was lowest, then he will get Rs. 37,500 (40,000 – 5% of 50,000). This amount is known as ‘prize money’ and the organizer will get Rs. 2,500. Balance Rs. 10,000 will be divided among all 25 members, i.e. each member will get Rs. 400 back. From next month, winner will not be allowed to participate in auction. Scenario for next 25 months with overall gain or loss to members is shown in Table no. 1 and 2:

Table No. 1
Month	Contribution	Prize money	Commission	Prize money after commission	Amount returned to members
1	2000	40000	2500	37500	400
2	2000	42000	2500	39500	320
3	2000	45000	2500	42500	200
4	2000	48000	2500	45500	80
5	2000	40000	2500	37500	400
6	2000	42000	2500	39500	320
7	2000	43000	2500	40500	280
8	2000	44000	2500	41500	240
9	2000	40000	2500	37500	400
10	2000	42000	2500	39500	320
11	2000	45000	2500	42500	200
12	2000	48000	2500	45500	80
13	2000	40000	2500	37500	400
14	2000	42000	2500	39500	320
15	2000	43000	2500	40500	280
16	2000	43000	2500	40500	280
17	2000	41000	2500	38500	360
18	2000	42000	2500	39500	320
19	2000	45000	2500	42500	200
20	2000	45000	2500	42500	200
21	2000	44000	2500	41500	240
22	2000	46000	2500	43500	160
23	2000	47000	2500	44500	120
24	2000	48000	2500	45500	80
25	2000	50000	2500	47500	0

This way total commission earned by the chit fund company/ organizer will come amount to Rs. 62,500. Now, let us look at the overall gain/ loss to each member.

Table No. 2
Member No.	Member’s total contribution	Prize money after commission	Total Amount returned	Profit/ Loss
1	50000	37500	6200	-6300
2	50000	39500	6200	-4300
3	50000	42500	6200	-1300
4	50000	45500	6200	1700
5	50000	37500	6200	-6300
6	50000	39500	6200	-4300
7	50000	40500	6200	-3300
8	50000	41500	6200	-2300
9	50000	37500	6200	-6300
10	50000	39500	6200	-4300
11	50000	42500	6200	-1300
12	50000	45500	6200	1700
13	50000	37500	6200	-6300
14	50000	39500	6200	-4300
15	50000	40500	6200	-3300
16	50000	40500	6200	-3300
17	50000	38500	6200	-5300
18	50000	39500	6200	-4300
19	50000	42500	6200	-1300
20	50000	42500	6200	-1300
21	50000	41500	6200	-2300
22	50000	43500	6200	-300
23	50000	44500	6200	700
24	50000	45500	6200	1700
25	50000	47500	6200	3700

Profits to the members depend upon the bid amount and to the wait for their turn. The last member will get full amount less of organizer’s commission.

Benefits of investing in chit funds

1) Availability of money when required, i.e. liquidity

2) Freedom to decide how much you want to save per month

3) Aids in developing the habit of savings

Drawbacks of investing in chit funds

1) High risk

2) Genuineness of chit fund company

Rest the table speaks for itself.

There are lots of better options in the market, if your basic motive is to save only. However, if you still feel like tasting the flavor of chit funds, then I will suggest you to be careful as the history has witnessed many cases where investors have suffered because of the frauds by the chit fund companies.