Meaning and working of a chit fund: A combination of savings and borrowings schemes, a chit fund is an arrangement where a group of people (called subscribers or members) get together and invest a fixed amount every month for a fixed period. The number of months for which the investment is made is equal to the number of subscribers in the scheme. The total amount collected every month is given out to one subscriber each month, based on a bidding system. Subscribers who need funds bid for an amount to be taken and the subscriber with the lowest bid is allowed to take the amount. The scheme is managed by one of the subscribers, who is called the Foreman. The Foreman is paid a fixed amount (generally 5% of the amount collected) as a fee for his efforts of collecting the subscription amount from the subscribers, recording details of members and conducting the auctions. This fee is deducted from the amount paid to the subscriber who wins the bid. The remaining amount is distributed equally among all the subscribers.
Let’s look at an example to understand the working better: A chit fund scheme of say, 20 members contributing Rs. 1000 each per month for 20 months amounts to a total monthly collection of Rs. 20,000. Assume there are 3 members who need funds during the month and participate in the bidding. One member bids for Rs. 18,000 while two others bid for Rs. 17,000. A lottery is drawn to determine which of the two members who bid for Rs. 17,000 is eligible for withdrawing the amount. This member can withdraw Rs. 16000 from the pool of money collected (the amount bid which is Rs. 17000 - Foreman’s fee of Rs. 1000 (5% of Rs. 20000)). The remaining Rs. 3000 (Rs. 20000- Rs. 17000) is distributed equally among all the members, ie: Rs. 150 each. So in effect, each member contributes only Rs. 850 for the month.
The next month, another member is given a chance to withdraw the bulk amount. Suppose this member bids for Rs. 18,000, the remaining Rs. 2,000 is divided among the members, ie: Rs. 100 per member. This process is repeated every month for a total of 20 months. During the 20 months, each member would have withdrawn a bulk amount once, and in addition received a nominal amount every month, which works like a dividend for the money invested. A member is allowed to withdraw the bulk amount only once and cannot participate in the bidding if he has already had his chance.
Different chit funds in various states have different rules with respect to choosing the member who withdraws the bulk amount every month and determining the withdrawal amount.
Regulation: Chits funds in India are regulated by various State and Central Acts. Chit Funds Act 1982 governs chit funds in India. Other than this, some states also have state-level laws to govern chit funds.
Should you invest in Chit Funds?
Chit funds are plenty in India. There are popular companies like Shriram Chits and Margadasi Chit Funds running chit fund schemes and there are several small unregistered ones too. The key to investing in chit funds is in choosing the right one. It is not advisable to invest in chit funds where you do not know the other members, as friends or relatives. While registered companies are regulated and governed by the Chit Funds Act, unregistered chit funds are not bound by such laws. Hence it is advisable not to invest in such funds, from a safety point of view.
Financially, a chit fund does not guarantee returns for an investor. As returns depend on the level of emergency of members for funds and this is a highly variable factor, it is not possible to calculate the returns you will earn from such schemes. Hence, they are essentially not investment products. However, a chit fund is a good saving tool for small investors. It brings about a discipline in saving regularly and is also useful in getting funds when in an emergency. You can therefore look at chit funds if you think you may need a huge amount in the near future and will not be able to get these funds from your bank. #gettingyourich