Are Chits Really Beneficial?

Today almost every middle class family is aware of chits. Most of them invest in chits thinking that they are a good investment option. In this article, let’s see whether they are really so.

A Chit Fund is a scheme wherein a group of people contribute towards the chit value and every member participating in the scheme agrees to pay a certain sum for a certain period. Each subscriber, as determined by a lot or by an auction, is promised to get a chit – a certain amount and the others share the dividends.

How Chit Fund Works?
Let’s say 30 people contribute Rs.2,000 per month for 30 months (equal to number of people in the group). That will make a total of Rs.60,000 every month. Now an auction is held to take this money. The person who bids for lowest amount wins the auction amount. Suppose of total 3 people who bid for 50,000/-, 52,000/- and 48,000/- the one who bids the lowest wins. In this case it is the person who has bid for Rs.48,000.

For every chit fund scheme, “organizer charges” are around 5% (typically) of the total amount is to be paid. In this case 5% of Rs.60,000, which is Rs.3,000 is taken by organizer. So, out of total 48,000/-, Rs.3000 will be deducted and the winner will get only Rs.45,000 and Rs.12,000 is the profit, which will be shared by the members (all 30 people). Thus, you see that the main winner is entitled to take a loss because of his need of getting the money and others benefited by it. Each person actually paid only Rs.1600, not Rs.2000. (In this case they got 400 back as dividend).

Advantages of Chits:

  • The rate of borrowing is much cheaper than other non-banking loans like money lender. You can borrow up-to 70% of the chit value, just by paying the first term (installment).
  • Suitable for unorganized economy group and needy people who are unsure of their cash flows and for their unexpected expenditure.
  • You can get finance without documents like PAN card, IT returns, bank statements, etc.

Disadvantages of Chits:

  • No security in unregistered chit fund companies. There are more chances of getting duped by these fraud companies.
  • Organizer gets benefited more from your savings.
  • No guarantee for fixed returns, as these returns are based on auctions.
  • In chits, interest earnings are lower than bank FDs.
  • You will save less money as the discount reduces the amount of principal invested will most likely the dividend saved be spend on other useless expenses. Thus reduces the amount of savings accrued.
  • There is very little protection.
  • High degree of risk is associated with chits, so relying on chit funds for saving could be more dangerous.
  • Chits cannot make money; it is just a mechanism for liquidity and emergency funds.

The advantages of investing in chits are often over emphasized when compared to their disadvantages. Therefore, an investment which is prone to high risk like chit fund should be considered as an inferior option.

Chit funds mainly run for saving the financial need of its group members. It is a good option for people who either don’t report their income or who work in the unorganized sector.

Earlier, people used to participate in chits as they don’t have other forms of finance. Mostly, because they did not have access to the banking channel or have no paper work to support their loan request. But these days, people working in organized market or paying taxes have more forms of finance available from various banks and financial institutions. Taking personal loans or using credit cards is more beneficial than investing in chits.

Above all, they neither provide safety of capital, better yield or interest nor more accumulation of savings.

You may also like to read:
Are Chits Really Beneficial? – Chit Funds vs. Fixed Deposits in Banks
Mutual Funds and Their Benefits
How to Choose an Equity Mutual Fund Scheme?
Direct Equity Investing vs. Investing in Equity Schemes

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