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Chit Funds vs Mutual Funds: Know the Difference

Chit fund in India, a popular savings scheme in India, originated in the 1800s when Raja Ravi Varma provided a loan with an equity claim. The Chit Fund Act 1982 defines chit-fund companies as those managing, supervising, and monitoring chit-funds in india, offering borrowing and saving opportunities. These investment plans are unique in nature so chit funds vs mutual funds gave better investment options through comparison.

In mutual funds, money is pooled between many investors, and then it is collectively invested. Both Mutual and chit funds in India are considered one of the best sources of income but are risky too.

In this article, we will explore Mutual Funds vs Chit Funds, which will help you to make a better and more informed decision if you are willing to invest in any of these two.

Read More: How to Get Monthly Income from Investment in India

What are Chit Funds?

Chit funds in india, known as chits, have served as investment and credit facilities for over a century, both formally and informally, and are recognized as vital microfinance instruments.

A trusted organizer gathers subscribers who contribute monthly, followed by a lucky draw or auction to determine the borrower. In the case of an auction, the lowest bidder wins, and the difference is distributed among subscribers. This monthly process continues until the chit-fund concludes.

A chit fund in India with 20 subscribers contributes Rs. 2,000 monthly; if the lowest auction bid is Rs. 38,000, the bidder receives that amount from the Rs. 40,000 collected. The remaining Rs. 2,000 is divided equally among the other members, resulting in approximately Rs. 105 each.

What are Mutual Funds?

Professionals with market expertise manage mutual funds that pool money from institutional and individual investors to collectively invest in a diversified portfolio of financial instruments, including equities, bonds, and money market instruments.

How do the Chit Funds Work?

For example, a chit fund in India has, a group of 10 individuals who contribute Rs. 1000 monthly for ten months, managed by an organizer who charges fees. In the first month, all 10 participants deposit Rs. 1000 each, creating a total pool of Rs. 10,000. Three people then bid different amounts: Person A bids Rs. 9000, Person B bids Rs. 7000, and Person C bids Rs. 8000.

The lowest bidder, Person B, receives Rs. 7000 but is charged 5% (Rs. 500) as organizer fees, resulting in Rs. 6500. The remaining profit of Rs. 3000 is divided equally among the 10 participants, giving each person Rs. 300. This monthly bidding process continues for 10 months.

How Does Mutual Funds Work?

Fund managers, possessing sound market knowledge, actively oversee and manage mutual funds, which pool money from investors to invest in various securities such as stocks and bonds. This makes mutual funds a little bit safer to invest in.

Chit Funds Investing Benefits

  • People can obtain a lump sum amount without documentation or collateral, unlike formal financial institutions.
  • Chit funds encourage and foster a savings habit among individuals at the grassroots level by requiring regular contributions of a fixed amount from each investor.
  • Chit funds provide a convenient savings option for financially backward communities and informal sector workers. Obtaining a loan from a financial institution without collateral and necessary documentation is challenging for them.
  • Chit funds offer versatility as a financial product, serving both as an investment and borrowing tool. Regular fixed deposits represent investments while winning an auction allows investors to borrow against future savings or subsequent installments.

Mutual Funds Investing Benefits

  • Fund houses follow SEBI’s guidelines and disclose their performances. This ensures complete transparency, which allows investors to have confidence in the transparency of their operations.
  • All kinds of investors find mutual fund investments convenient since they can deposit a lump sum of their investment money or choose to deposit it periodically through the SIP investment mode.
  • Investing in mutual funds assures ample growth opportunities for your money, as they explore diverse securities and provide the advantage of diversification.
  • They mitigate market volatility losses by investing in different asset classes and market capitalization.
  • Fund managers, with their expertise, tackle market-related challenges on behalf of investors. They utilize their experience and resources to identify suitable investments and determine optimal entry/exit timings.

Limitations of Chit Funds in Investment

  • Chit funds have high transaction costs and are susceptible to scams.
  • Dishonest individuals often make unfulfilled promises of substantial ROI, taking advantage of investors’ limited financial literacy.
  • Unregistered chit funds, lacking legal regulation, enable organizers to misuse pooled money without being held accountable.
  • Organizers of unregistered chit funds often expand the group without assessing the creditworthiness of members, typically known to each other.
  • Registered chit groups must deposit 100 percent of the chit value with the Registrar of Chits at the scheme’s start, with a refund at the end.
  • Some registered chit companies avoid paying this amount by operating unregistered groups. Therefore, investors should ensure scheme compliance with regulations.
  • There is a risk of members defaulting on payments after winning previous auctions.
  • Certain chit funds may manipulate discount rates, causing desperate investors to pay higher discounts.

Limitations of Mutual Funds in Investment

  • Investors should evaluate the expense ratio when selecting schemes, as it represents the cost of fund management. High expense ratios typically result in lower returns, but it does not necessarily guarantee a fund’s good performance.
  • Portfolio diversification generates benefits, but it can also dilute profits.
  • Certain AMCs impose high exit loads to discourage early withdrawals, requiring investors to pay if they exit the fund before a specified date.

Key Differences Between Chit Funds and Mutual Funds 

Mutual funds and chit funds are the best sources of earning, but before deciding between the two you should have a clear understanding of both. Here is a short glimpse at both:

Difference

CHIT FUNDS MUTUAL FUNDS

 

Operational method

Members contribute monthly, and the fund is auctioned to a single participant in each cycle. Investors pool money that is then invested in securities.

 

Operated by

In formal cases, a financial institution serves as the organizer, while informally; a trusted individual fulfills that role for the subscribers. Fund houses or AMC

 

Expenses

Organizers charge for the services. This is typically more than 5%. AMCs take a certain percentage of the yield.

 

Reason for Investing

As a short-term income source. To get returns on surplus income

 

Minimum and Maximum Value

Legally, the maximum chit amount varies depending on the number of subscribers. Systematic Investment and usually, there is no maximum value.

 

Rate of Return

 

It varies from one to another.

It is not fixed and is going through market performance.

 

Level of Risk

 

Unregistered chit funds are highly risky because lack of regulation.

Varying levels of risks for different funds. They are also subject matter to market risk.

 

Maturity Period

 

Usually, it lasts for as several months as there are members.

 

No specific date or tenure. Investors can exit the fund at any time. Investors can choose to invest in the short, medium, or long term.

 

Types

 

Both Registered and Unregistered.  

 

Open-ended and closed-ended in terms of entry and exit from the fund. Equity, money market, and debt funds in terms of types of investments.

 

Level of Liquidity

In formal chit funds, withdrawals require approval from the organizer for specific reasons, while informal exits are possible by paying a nominal exit cost.  

Mutual funds offer a relatively high level of liquidity, allowing investors to withdraw their money, even within a day. However, early withdrawals from open-ended mutual funds may incur an “exit load” fee imposed by the AMC.

 

Tax Efficiency

The returns from chit funds are generally tax-exempt, but they need to be declared while filing income tax returns.  

Different mutual funds have different tax rates for short and long terms. 

Chit Funds or Mutual Funds Choose the Right One

Both chit funds and mutual funds are legal and the best source of income. But choosing between the two (chit fund and mutual funds) depends upon your risk-taking ability. chit funds in India are a lot more profitable but are not as secure as mutual funds. Therefore the Chit Funds vs Mutual Funds fight arises. 

Professionally managed mutual funds offer market-linked returns to all stakeholders, requiring a thorough evaluation of past performance, management, and risk ratios.

The better option between mutual funds and chit funds depends on the investor’s goals and associated pros and cons. An investor should assess their goals, risk tolerance, and investment duration and weigh the pros and cons to make an informed decision.

Conclusion

When comparing chit funds and mutual funds, it is crucial for investors to thoroughly evaluate their preferences, goals, and risk tolerance to make an informed decision that aligns with their financial objectives. While mutual funds offer professionally managed market-linked returns to all stakeholders, chit funds in india operate on a more localized level with potential benefits such as ease of access and flexibility.

However, the choice ultimately depends on factors such as desired investment outcomes, willingness to take risks, investment duration, and other specific considerations. By weighing the pros and cons of each option and considering their overall financial plan, investors can make a well-informed choice that suits their circumstances.

Chit Funds vs Mutual Funds – FAQs

Chit Funds vs Mutual Funds the most important difference between the two?

Ans. The main difference is that mutual funds pool money from investors to invest in securities, while chit funds involve a group of individuals contributing money together and taking turns to receive the pooled amount.

Chit Funds vs Mutual Funds Which is best for long-term investment?

Ans. Mutual funds are generally considered suitable for long-term investments as they provide the opportunity to participate in market returns over an extended period.

Chit Funds vs Mutual Funds How does their return mechanism differ from each other?

Ans. In mutual funds, returns are based on the performance of the investment portfolio, which is distributed among all investors. In chit funds, returns come from winning bids during the auction, where the lowest bidder receives the pooled amount.

Chit Funds vs Mutual Funds who offers more professional management?

Ans. Mutual funds are professionally managed by experienced fund managers who make investment decisions on behalf of investors. Chit funds, on the other hand, are typically organized by a trusted individual within the group of contributors.

What factors should be considered when choosing between chit funds and mutual funds?

Ans. Factors to consider before choosing between chit fund and mutual funds include investment goals, risk tolerance, desired liquidity, investment duration, and evaluating the past performance, management, and risk ratios of mutual funds. For chit funds, factors include trust in the organizer and understanding the terms and conditions of participation.

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