Which investment is better, a mutual fund or a chit fund?
Saving money a little every month can be a blessing when a dire financial need strikes us. A small amount gradually grows over the months and years to become a lumpsum amount even before you know it!
You could also enjoy dividends and interests depending on which financial instrument you invest! Two of the most common investment tools are the Chit Funds and Mutual Funds.
Both these tools allow you to save a small amount consistently to form a bigger saving amount. In both cases, people come together to pool their money periodically i.e. mostly monthly.
Before we jump into the difference between chit funds and mutual funds, let’s get familiar with the basics.
Chit Fund
In a chit fund, a specified number of people agree to subscribe to a certain amount of money by periodically paying installments. The pooled fund can be won either through bidding (auction) or by casting lots.
The person whose name appears on the lot or one who bids for the lowest amount wins the prize money. And the winner must continue to pay the installments for the remaining number of months.
Today most of the Chit fund is a regulated business under the Chit Funds Act, 1982 and If it is not regulated, there are high chances of you getting scammed.
How Do Chit Funds Work?
In a lucky draw or lots, whose ever name is picked, that person will have access to the pooled money. And from next month his/her name will not be included in the lucky draw. Although he must continue to pay the installments for the remaining months.
You can easily understand the auction method with the following example:
Let’s assume 10 people decide to pay 1,000 every month. So the first month you will have (1,000 X 10) or Rs. 10,000.
Now, this 10,000 will be put for auction. The person who bids the lowest can take the prize money. Let’s say Karan bids for Rs. 9,000, Jay bids for Rs. 8,000, and Firoz bids for Rs. 7,000. Now, Rs.7000 is the lowest bid therefore this amount will be given to Firoz.
The foreman or organizer generally takes a 5-10% commission for organizing the chit fund. If we consider the foreman commission to be 5% then 5% of Rs. 7,000 (Rs. 350 ) will be taken by the chit fund organizer.
Now, the remaining Rs. 3,000 will be divided equally among them i.e. Rs. 300 for each member. This process will continue for 10 months.
Why are Chit Funds Beneficial?
1. Savings & Borrowing: Chit funds work as a simple financial instrument for any economic group to save and borrow!
2. Easier Credit Access: Its main aim is to provide easier credit access
3. Market Risk: Chit funds don’t face any market risk as the funds are not being invested in shares or bonds.
Mutual funds are one of the most common savings and investment instruments across the globe. Thus thousands of people can invest in a fund once SEBI approves! Since SEBI is involved mutual funds are deemed more trustworthy and are regulated by the SEBI (Mutual Funds) Regulations, 1996.
How Do Mutual Funds Work?
Mutual funds pool in money from investors and issue units at the Net Asset Value (NAV) also called market value as per the date of their investment. It allows savings through small investments in systematic investment plans (SIP) as well as investing as a lump sum amount. The Asset Management Company (AMC) or the Fund Manager manages the funds collected.
The AMC now invests the funds in numerous securities based on their investment goals. As mentioned above, the units of a mutual fund carry a NAV. This NAV keeps getting altered as per the market condition and directly impacts the growth or fall of your investment.
When the NAV increases, your investment will grow, and when it decreases, your investment will reduce. As an investor, you can choose to have a growth option where the value of your stocks and bonds increases or the dividend option, which will offer dividends monthly, bi-annually, quarterly, or annually.
Mutual Funds Benefits
1. Huge Growth: Investing in Mutual Funds opens doors to huge growth for your money.
2. Investments Small And Big: You can make small investments through SIP or invest a lumpsum amount!
3. 100% Transparency: Mutual Funds need to display their financial performance publicly as per SEBI’s regulations making it 100% transparent in their operations.
This section will help you understand which financial tool best suits your needs:
Chit Funds | Mutual Funds |
Traditional saving & borrowing tool with nil or low-interest rate on borrowing and high dividend on long term investment | Traditional saving & investment tool with options for huge money growth. |
Regulated by the Chit Funds Act, 1982 | Regulated by SEBI Act, 1996 |
Prize money is won by auctions | Dividends or increased share value is gained |
Run by registered chit funds | Run by professional fund managers or AMC regulated by SEBI |
Low-risk investment, as your investment value is not wavering because of the market condition. | High-risk investment as your NAV keeps wavering because of the market condition. |
Minimum or nil documentation | Must have all your documents to invest |
Foreman commission of 5%-10% needs to be paid when you win the auction. | Managing expense of 2%-3% needs to paid annually. |
Summing Up:
Now that you know what and how a chit fund and mutual fund works, you can decide for yourself the financial instrument you want to invest in!
If you are willing to take risks and enjoy great growth, Mutual funds will be the best investment option for you.
But if you are looking for immediate funding for your business or personal needs without much documentation or interest, Chit fund is an ideal option for you!
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