Avoid chit funds

Last Updated: Fri, Apr 12, 2013 09:51 hrs

Recently, Securities and Exchange Board of India (Sebi) Chairman U K Sinha, pointed out that unauthorised collective investment schemes (CIS) such as chit funds and nidhi companies are one of the reasons for the dip in household savings and the share of financial products in household savings. Sinha pegged the amount involved in such unauthorised CIS at more than Rs 10,000 crore.

Regulating CIS falls under Sebi jurisdiction. However, nidhi companies, chit funds and cooperatives have been kept out of the Sebi Act. Such chit funds and nidhi companies have been around in India for several years. Not all of these are regulated. Many of them work on word of mouth basis. People working in a company or people staying in the same locality form a group. They float a chit fund and gather funds from all the members, with promise to give high returns. But, if the company folds up it is almost impossible for investors to get the money back.

Jehangir Gai, consumer activist says it is the lure of higher returns that often see people willing to sacrifice the principal amount and agree to invest in such schemes. "But one must remember that often, when such companies achieve a broader investor base, they may just fold up and disappear. So, it is best to avoid them," he says.

People prefer to invest in chit funds since they offer easy liquidity where investors can withdraw money easily in case of an emergency, something that may be difficult in case of other investments. So, if you are looking to invest in a chit fund look for one that is registered and regulated. Chit funds are regulated by state and central governments. This way, if something goes wrong, you can lodge a complaint with the authorities.

Unlike bank deposits, which are guaranteed under the Deposit Insurance and Credit Guarantee Corporation, there is no such guarantee for the funds invested in chit funds. Since liquidity is cited as the biggest advantage of a chit fund, invest in them only if you know for sure that you need funds in a short period of time. But, also consider options like a loan against your bank fixed deposit (FD). Suresh Sadagopan, a certified financial planner, agrees it is best to avoid companies that promise returns in the range 18 per cent, when bank FD rates are 9-10 per cent, because if it sounds too good to be true, then it probably is not true.

In case you think of investing in a chit fund, make sure it is one where other members are known to you. Joining an unknown group is risky, because again if the group folds up overnight, there is no one who can be held accountable. "Thus, the key to investing in chit funds is in choosing the right one," says Adhil Shetty of Bankbazaar.com. From the investment point of view a chit fund does not promise returns. It is not possible to calculate exact returns from a chit fund as it depends on the level of emergency of members for funds, and this is a highly variable factor, Shetty adds.

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