Investing in Chit Funds …First Understand How They Work

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:

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.

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.