Mutual Funds vs Chit Funds: What is the Difference Between a Mutual Fund and a Chit Fund?


Mutual funds vs. Chit Funds

Mutual Funds vs Chit Funds

Small savings can lead to big changes in real life. We have always understood and appreciated the importance of saving a small amount so that it gradually grows over a period of time. You will be happy to know that there are many tools in the market that work around the same concept. Two of the most famous ones are – Mutual funds and Chit Funds.

Both mutual funds and chit funds allow a person to save a small amount in a gradual manner to form a bigger saving corpus. Both concepts involve people coming together to pool their small amount of money over a periodic basis (mostly monthly). Before we tell what’s the difference between a mutual fund vs. chit fund, let’s learn a bit more about both.

What is a Chit Fund?

Chit fund is over a 100 year old concept. Back in time, when there was no bank facility available and people in villages and cities needed urgent money for a marriage in the house or a medical emergency, they could get a lump sum through a chit fund. 

Chit funds are also called chitty and kuree etc. Chit funds are similar to a kitty party but the only difference is that unlike in a kitty party, the winning member is not chosen by a draw of lots, but through an auction.

The concept behind a chit fund is that a person enters into an agreement along with other people (a specified number of trustworthy people) in a way that all of them shall subscribe to a certain amount of money through periodical instalments over a definite period of time..

When the person’s turn comes, either by claiming it himself or by some kind of auction he draws the amount of money he needs. By means of periodical installments over a time period, he must repay the money gained.

Chit funds companies that began by providing loans to traders and businessmen to help with their financial problems are now a regulated business. Chit funds are regulated under the Chit Funds Act, 1982. 

Note that a chit fund can be formed only with the prior sanction of the state government otherwise you can get scammed. 

How do Chit Funds work?

We can show you how a chit fund works perfectly with the help of an example. Let’s say there is a group of 20 people who decide to pool Rs. 1,000 every month. Now, this will mean that in the first month, the amount of money that will be accumulated will be (1,000×20) or Rs. 20,000. 

Now, this Rs. 20,000 will be put to bidding and will go to the person who puts out the lowest bid. Say, Person A quotes Rs. 19,000, Person B quotes Rs. 18,000 and Person C quotes Rs. 17,000. Now, Rs. 17,000 being the lowest bid, this money will go to Person C. 

The organizer of the chit fund generally takes a cut of 5-10% which will here mean that 5% of Rs. 17,000 which is Rs. 850 will go to the chit fund organizer.

Now, the remaining (Rs. 20,000 – Rs. 17,000) Rs. 3,000 will be divided among the 20 people equally. This means that every person will get Rs. 150 monthly. Since there are 20 people in the chit fund here, this process will continue for 20 months. 

Why are Chit Funds Beneficial?

1. Easier Credit Access: The main aim of a chit fund is to provide easier credit access when much needed.

2. Savings & Borrowing: Chit funds are traditionally a savings cum borrowing scheme.

3. Nil Market Risk: It is a saving instrument that isn’t subjected to any market risk or volatility. 

Famous Chit Funds in India

Chit funds are a popular savings option but are limited mostly to India. We don’t see any popular chit fund companies in any other part of the world. Some of the most famous and successful chit fund houses are:

  1. Kerala State Financial Enterprise (KSFE) — Government of Kerala
  2. Mysore Sales International — Government of Karnataka
  3. Shriram Chits — Shriram Group
  4. Margadarsi Chits — Ramoji Rao Group

What is a Mutual Fund?

Mutual funds are a universal saving and investment instrument. They allow thousands of people to come and invest under the same umbrella. They allow a person to invest in a fund along with thousands of other people, after the approval of SEBI. Since SEBI is a government ruled body, one can say that mutual funds are always trustworthy, unlike chit funds. They are regulated by the SEBI (Mutual Funds) Regulations, 1996.

How do Mutual Funds work?

Mutual funds pool in money from willing subscribers and issue units at the market value (called NAV) as on the date of investment. Mutual funds allow savings through systematic investment plan (SIP) as well as lump sum investments. It is the function of an Asset Management Company (AMC) to manage the funds collected from investors. 

An AMC invests the funds in various securities based on the investment goals of a particular mutual fund scheme. Units of a mutual fund carry a market value as told above. That market value or NAV keeps on changing as per the market condition and this is what leads to the growth (or fall) of your investment amount. 

When this market value goes up due to the change in market condition, your investment will grow. If the market value falls, then the investment amount will fall. An investor can choose between the regular dividend option and a growth option in a mutual fund.

If they choose the dividend option, the investor would receive regular dividends declared by the mutual fund. While if they choose the growth option, the investor does not receive any dividend. Remember that the growth plan offers higher NAV as compared to a dividend option. In both cases, investors can redeem or sell the units at the NAV as on the date of redemption. 

(Read More: How to invest in mutual funds?)

Why are Mutual Funds Beneficial?

1. Growth Opportunity: Mutual funds are a great investment option that offer huge growth opportunities for your money.

2. Small and Big investments: Mutual funds are convenient as they offer the option to invest a small amount multiple times through SIP or a big amount once though lump sum.

3. Complete Transparency: Mutual funds have to offer public disclosure of their financial performance under SEBI’s regulations. 

(Read More: How to start an SIP?)

Mutual Funds vs Chit Funds

Let’s read more about Mutual Funds vs Chit Funds and which one is a more suitable option for you:

Mutual Funds 

Chit Funds

   

They are traditionally a saving and investment tool as help in growing the money through investment. 

They are traditionally a saving and borrowing tool that don’t help in growing money through investment.

Offer transparency about their financial performance to the public under SEBI’s regulation.

They don’t offer complete transparency as there have been cases in which the chit fund organizer has duped people out of their money.

Run by professional fund managers and AMCs that are regulated by the government.

Run by family chit fund houses that may or may not be regulated by the government.

Managed by the fund house at a small annual expense at 2% or 3%.

Managed by the chit fund organizer at an expense of 5% or 10% monthly making it a huge 60% over the annum.

 

Written by

Priyanshi Bhardwaj