Indians traditionally know the value of small and regular savings. Community savings and pooled savings have been the oldest form of self-help schemes. While there have been chit funds for pooling resources, the modern mutual funds offer returns along with pooling.
A small investor subscribing to a pool would look at the monetary commitment, the time period involved, return on investments, financial risk, ease of redemption and the lump sum funds.
There are various savings schemes, which meet most of the criteria mentioned above. In this article, we discuss two such schemes, namely chit funds and mutual funds.
Chit funds:
Chit funds are one of the traditional savings schemes long before people began post office savings. The history of chit funds dates back to the 1800s, the initial one being under the then ruler of erstwhile Cochin state Raja Rama Varma. The king gave a loan to a Syrian Christian trader, by retaining a certain portion for himself, and later he claimed the money on the principle of equity.
Chit funds are traditionally a savings cum borrowing scheme. Chit funds or Kuri companies, which began by providing loans to traders and merchants to tide over financial problems are now a regulated business. Chit funds are regulated under the Chit Funds Act, 1982. A chit fund can be formed only with the prior sanction of the state government.
In a chit fund, a person enters into an agreement with a certain number of people that everyone shall subscribe a certain amount of money through periodical instalments over a definite period of time. The subscribers make contributions to the fund from time to time. Periodically, one of the subscribers is chosen by a lot or by auction to receive the prize money from the chit fund.
For example, if 30 members pool in Rs 1,000 every month, they will have a corpus of Rs 30,000 to start. Upon pooling of the monthly sums, members can bid for the money. If five subscribers bid for the money, the person who bids the lowest is entitled to the money. Let’s say the lowest bid is Rs 24,000.
The organiser charges 5% amounting to Rs 1,500. The bidder receives Rs 24,000 and the balance Rs 4,500 is divided among the 30 subscribers. Each subscriber receives Rs 150 back from the fund. The process repeats for the entire period of 10 months.
Also Read: The Transition of Investors from Real Estate to Mutual Funds
Mutual Funds:
Mutual funds are collective investment schemes. The funds pool in money from willing subscribers and issue units at the market value as on the date of investment. Mutual funds encourage small savings through systematic investment plan (SIP) as well as lump sum investments.
Mutual funds are regulated by the SEBI (Mutual Funds) Regulations, 1996. An asset management company (AMC) manages the funds collected from investors. The AMC invests the funds in various securities based on the investment goals of the mutual fund scheme.
The units of a mutual fund carry a market value based on the net asset value (NAV) of the fund. The market value undergoes a change depending on the underlying investments of the fund.
An investor has the option to subscribe for a regular dividend option or a growth option in a mutual fund. Under the dividend option, the investor would receive regular dividends declared by the mutual fund. Under the growth option, the investor does not receive any dividend. However, 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.
Differentiating factors:
Mutual funds are investment schemes, unlike a chit fund. While a chit fund offers mutual help through the facility borrowing, a mutual fund offers growth in investment and ease of redemption. An individual who seeks growth would prefer mutual funds in the place of chit funds.
Both chit funds and mutual funds are governed by different regulations. However, mutual funds are more transparent due to their public disclosure norms under SEBI’s regulations. Mutual funds disclose their financial performance to the public.
When it comes to management, mutual funds have professional management as compared to chit funds which are mostly family-run businesses such as Shriram Chits of the Shriram group.
The financial risks involved are different, though. In mutual funds, there are financial risks associated with the performance of the underlying securities. The market values of securities are subject to market forces, economic and other financial data. In the case of chit funds, while certain chit funds are historically financially secure, certain others use the garb of chit funds to dupe public money such as Saradha chit fund scam.
Mutual funds offer professional management, transparency, return on investment and safety against financial frauds. Mutual funds also offer tax saving advantages in the form of Equity Linked Savings Scheme (ELSS) with a lock-in period of three years.
The modern investor is tech-savvy. An individual would want to know the advantages and risks involved in the investment as well as ease of investing. Mutual funds offer most of the advantages compared to chit funds.
For any clarifications/feedback on the topic, please contact the writer at sweta.dugar@cleartax.in
I am a Chartered Accountant by profession. I specialise in personal taxes and corporate income tax matters. I am an avid reader and track developments in financial markets, economy and other market developments.
